Monthly Archives: April 2012

Section 13(d) Reporting Requirements Need Updating

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. This post discusses a letter submitted to the SEC by Professor Lucian Bebchuk and Professor Robert J. Jackson Jr. concerning possible changes to Section 13(d) rules, available here.

A year has passed since Wachtell, Lipton, Rosen & Katz submitted a petition to the U.S. Securities and Exchange Commission requesting that it update its Schedule 13D reporting requirements to “clos[e] the Schedule 13D ten-day window between crossing the 5 percent disclosure threshold and the initial filing deadline, and adopt[] a broadened definition of ‘beneficial ownership’ to fully encompass alternative ownership mechanisms.” As the petition noted: “Recent maneuvers by activist investors both in the U.S. and abroad have demonstrated the extent to which current reporting gaps may be exploited, to the detriment of issuers, other investors, and the market as a whole.” [1] The SEC is scheduled to issue a concept release later this spring addressing the concerns raised by the petition. Activist hedge funds have responded strongly—opposing changes to the current Schedule 13D rules—complaining that the suggested changes will significantly hurt their business. Regardless of whether the present reporting scheme allows activist investors to profit by keeping their accumulations secret, it is clear that the present reporting regime is outdated and needs to be reconsidered. At a time when the SEC is requiring greater transparency from public companies and their executives, the same policy concerns demand greater transparency with respect to the acquisition of equity securities of public companies by third parties.


Say on Pay: Who Is Watching the Watchmen?

Joseph Bachelder is founder and senior partner of the Bachelder Law Firm. This post is based on an article by Mr. Bachelder, with assistance from David T. Ling and Andy Tsang, which first appeared in the New York Law Journal.

This column looks at four circumstances having special impact on the governance of executive pay today and then focuses on one of them, proxy advisers (with particular attention to the largest one, Institutional Shareholder Services (ISS)). It concludes with suggestions as to steps that might be taken to better regulate proxy advisers.

Four Influential Factors

Increasing Complexity of the Executive Pay Discussion. Discussions of executive pay in proxy statements are often extremely complex and lengthy (frequently 30 to 40 pages of narrative and tables). Many companies are putting into the Compensation Discussion and Analysis (CD&A) their own tables (most especially their own competing version of the Summary Compensation Table) in order to express their own views on the correct way to explain and justify executive pay at the issuer. It has become a challenge to understand any one company’s executive pay arrangements and an even greater challenge to understand how that company’s executive pay arrangements relate to those at competitor companies.

Institutional Shareholders. Institutional shareholders represent an overwhelming proportion of the vote at publicly traded companies. (They own approximately 75 percent of the market value of exchange- traded companies.) These institutional shareholders owe a fiduciary duty to the persons who own their shares or are beneficiaries of the trust funds managed by them. This duty includes understanding how the companies in which they have invested are managed, including management of executive pay. The explosion of data noted in the preceding paragraph has meant a challenge to these institutional shareholders in trying to understand the executive pay practices at thousands of companies that they (collectively) are investing in.


Risk-taking by Banks

The following post comes to us from Sugato Bhattacharyya and Amiyatosh Purnanandam, both of the Department of Finance at the University of Michigan.

Excessive risk-taking by banks is widely blamed as a primary factor behind the financial meltdown of 2007-2008. Yet, not much work has been done on whether banks fundamentally changed their risk-taking behavior prior to the crisis, nor has much formal work been done on whether banks’ risk-taking was “excessive” in any way. In our paper, Risk-taking by Banks: What Did Banks Know and When Did We Know It?, which was recently made publicly available on SSRN, we tackle these questions head on and also examine possible motives for bank managers to have changed their risk-taking behavior in the years leading up to the crisis.

In the years 2000 to 2006, a preliminary examination of stock price volatility does not seem to support the idea that the financial markets deemed the level of risks assumed by banks to be excessive. But we document a remarkable compositional shift in the measures of risk-taking: bank’s systematic risk, measured by their equity betas, almost doubled while their idiosyncratic volatility came down significantly. This reduction in idiosyncratic risk is consistent with the increasing reliance on securitization to shed firm-specific risks. But the remarkable increase in betas clearly shows that bank assets were becoming increasingly similar in terms of their risk characteristics and that future bank performance was viewed as much more dependent on the performance of the macro-economy. Our results indeed indicate major changes in the nature of risk-taking by banks in the years preceding the crisis.


Thirty-Six Precatory Declassification Proposals Going to a Vote at Annual Meetings

Editor’s Note: Professor Lucian Bebchuk is the Director of the Harvard Law School Shareholder Rights Project (SRP), and Scott Hirst is the SRP’s Associate Director. Any views expressed and positions taken by the SRP and its representatives should be attributed solely to the SRP and not to Harvard Law School or Harvard University. An initial post about the SRP’s activities during this proxy season is available here, a critique of the SRP’s activities by Martin Lipton and Theodore Mirvis is available here, a response to this critique by Jeffrey Gordon is available here, and a recent post about companies disclosing management declassification proposals made pursuant to agreements is available here.

This post provides information about thirty-six precatory board declassification proposals, submitted by institutional investors represented and advised by the Harvard Law School Shareholder Rights Project (SRP), that are expected to go to a vote at annual meetings during this proxy season.

During the 2011-12 proxy season, the SRP has been representing and advising several institutional investors – Illinois State Board of Investment (ISBI) , the Los Angeles County Employees Retirement Association (LACERA), the Nathan Cummings Foundation (NCF), the North Carolina Department of State Treasurer (NCDST), and the Ohio Public Employees Retirement System (OPERS) – in connection with the submission of precatory shareholder proposals to more than eighty S&P 500 companies that have classified boards. The proposals urge repealing the classified board and moving to annual elections, which are widely viewed as corporate governance best practice.

Through active engagement with companies receiving declassification proposals, the SRP and the institutional investors working with the SRP have been able to reach negotiated outcomes with (as of today) forty-four of the companies receiving such proposals. These companies have entered into agreements committing them to bring management proposals to declassify their boards. (A partial list of companies entering into such agreements, including only companies that have already made public filings that disclose the planned management proposals, is available here.)

In many other companies receiving proposals, however, the SRP and the institutional investors working with the SRP have not been able to obtain such negotiated outcomes. In such cases, the shareholder proposals urging board declassification are expected to go, or have already gone, to a vote at 2012 the annual meeting.

Thus far, only one proposal has gone to a vote. The proposal, submitted by the Illinois State Board of Investments to the F5 Networks, Inc. (FFIV), won 77% of the votes cast.

Below is a list of thirty-six companies where shareholders are expected to vote at the 2012 annual meeting on shareholder proposals submitted by institutional investor represented and advised by the SRP. Where the proxy statement has already been issued, the date of the meeting and a link to the proxy statement are also provided. The list does not include companies where a dialogue is still ongoing. The list will be updated periodically and the most updated version is available here.


Shareholder Votes and Proxy Advisors

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.

In the paper, Shareholder Votes and Proxy Advisors: Evidence from Say on Pay, which was recently made publicly available on SSRN, my co-authors (Yonca Ertimur of Duke University and David Oesch of the University of St. Gallen) and I examine the analyses underlying the voting recommendations issued by Institutional Shareholder Services (ISS) and Glass Lewis & Co. (GL), the two most influential proxy advisors, for the non-binding vote on executive pay mandated by the Dodd-Frank Act, also known as “say on pay” (SOP). We then investigate the effect of these recommendations on shareholder votes, stock prices and firm’s behavior. Due to the complex and highly firm-specific nature of executive compensation, mandatory SOP votes provide an especially powerful setting to examine the analyses performed by proxy advisors and their impact.

Our analysis of the SOP-related part of the ISS and GL proxy reports for S&P 1500 firms in 2011 shows that both advisors provide a quantitative and qualitative examination of the executive pay plan (structured around certain categories, e.g. pay for performance, disclosures), assign a rating for each category and issue a final voting recommendation (For or Against). ISS issues Against recommendations for 11.3% of the firms and GL for 21.7%, suggesting a more aggressive stance by GL. The difference also reflects the different approaches ISS and GL follow in assessing the “pay for performance” category, a key driver of the final recommendation, with ISS focusing its analysis of pay practices mostly on poorly performing firms. Firms receiving an Against from ISS are not a subset of those receiving an Against from GL. Rather, among firms with potentially questionable executive compensation practices (i.e. firms with an Against from at least one proxy advisor), ISS and GL agree on which firms warrant an Against only in 17.9% of the cases. We interpret this as evidence that the complex nature of SOP has allowed proxy advisors to differentiate themselves from each other. Additional analysis suggests that neither proxy advisor applies a “one-size-fits-all” approach in evaluating the compensation plans for the 2011 proxy season. Specifically, there are numerous cases where the proxy advisors identify similar controversial provisions yet issue different recommendations, based on firm-specific circumstances and other elements of the pay plan.


The Influence of Proxy Advisory Firm Voting Recommendations

Matteo Tonello is Director of Corporate Governance for the Conference Board, Inc. This post is based on a Conference Board Director Note by David F. Larcker, Allan L. McCall, and Brian Tayan; the full publication, including charts, survey results, and footnotes, is available here.

This report examines current evidence regarding the influence of third-party proxy advisory firms’ voting recommendations on shareholder proposal voting outcomes, particularly say-on-pay votes. It also presents the findings of a study, conducted by The Conference Board, NASDAQ, and the Rock Center for Corporate Governance at Stanford University, which shows that proxy advisory firms have a substantial impact on the design of executive compensation programs. However, the impact of those firms on governance quality and shareholder value is still unknown.

A growing body of evidence demonstrates the influential role that third-party proxy advisory firms play in affecting the voting outcome of proposals made to shareholders in the annual proxy, particularly say-on-pay votes, which became mandatory for most public companies in 2011. There is less evidence, however, to establish the extent to which companies respond to this influence by changing the size and structure of executive compensation plans to conform to proxy advisor voting polices. A recent study conducted by The Conference Board, NASDAQ, and the Rock Center for Corporate Governance at Stanford University found that proxy advisory firms have a substantial impact on the design of executive compensation programs.


Differences Between US and UK Market Abuse Regimes

The following post comes to us from John H. Sturc, co-chair of the Securities Enforcement Practice Group at Gibson, Dunn & Crutcher LLP, and is based on a Gibson Dunn alert by Mr. Sturc, Jeffery Roberts, Selina Sagayam, James Barabas, and Edward Tran.

The UK Financial Services Authority (“FSA”) imposed fines of £3.651 million ($5.77 million) on Greenlight Capital Inc., a US hedge fund manager (“Greenlight”), £3.638 million ($5.74 million) on David Einhorn, Greenlight’s owner, and £350,000 ($553,000) on Andrew Osborne, a former Bank of America Merrill Lynch banker. These fines were levied in connection with Greenlight’s trading in the shares of Punch Taverns Plc (“Punch”), a UK pubs business, ahead of a planned equity offering. The FSA imposed the fines on the grounds that Greenlight traded on inside information conveyed to David Einhorn during a conference call with Punch’s CEO and Andrew Osborne, its broker. Greenlight specifically declined to be made an insider for the purposes of the call and David Einhorn requested that he would not be “wall crossed.” Notwithstanding this, the FSA determined that the information conveyed amounted to inside information, that trading on this information was prohibited by the UK’s market abuse regime and that Greenlight, David Einhorn and Andrew Osborne should have been aware of this. It is unlikely that Greenlight’s trading would have triggered an enforcement action by the US Securities and Exchange Commission (“SEC”) if it had occurred in the context of a US exchange. However, US financial institutions and other market participants active in UK financial markets should take note of the FSA’s actions as this case illustrates key differences between the regulation of insider trading and market abuse in the US and the UK, and the FSA’s more aggressive policing of UK markets.


The JOBS Act and General Solicitation

The following post comes to us from Latham & Watkins LLP, and was coauthored by Latham and thirteen other firms, who are listed at the end of the memorandum. The memo is available here.

President Obama signed into law this week the Jumpstart Our Business Startups Act (JOBS Act). Title II of the JOBS Act affects offerings by issuers pursuant to Regulation D under the Securities Act, as well as resales under Securities Act Rule 144A. In particular:

  • Section 201(a)(1) of the JOBS Act directs the Securities and Exchange Commission (SEC) to amend Rule 506 to make the prohibition against general solicitation or general advertising contained in Rule 502(c) inapplicable to offers and sales under Rule 506, provided that all purchasers are accredited investors.
  • Section 201(a)(2) requires the SEC to revise Rule 144A to provide that securities sold under Rule 144A may be offered to persons other than qualified institutional buyers (QIBs), including by means of general solicitation or general advertising, provided that securities are only sold to persons reasonably believed to be QIBs.
  • Section 201(b) amends Section 4 of the Securities Act to provide that offers and sales exempt under Rule 506 as revised by Section 201 “shall not be deemed public offerings under the Federal securities laws” as a result of general advertising or general solicitation.

Section 201(a) requires the SEC to amend both Rule 506 and Rule 144A not later than 90 days after enactment of the JOBS Act. The following questions and answers reflect the current understanding of the undersigned law firms regarding transactions taking place during the period prior to the date the SEC’s amendments of Rule 506 and Rule 144A implementing Section 201(a) take effect (the interim period).


Are Overconfident CEOs Better Innovators?

The following post comes to us from David Hirshleifer and Siew Hong Teoh, both of the Paul Merage School of Business at the University of California, Irvine, and Angie Low of Nanyang Business School at Nanyang Technological University.

In our forthcoming Journal of Finance paper, Are Overconfident CEOs Better Innovators?, we find that over the 1993 to 2003 period, CEO overconfidence is associated with riskier projects, greater investment in innovation, and greater innovation as measured by the number of patent applications and patent citations even after controlling for the amount of R&D expenditures. In other words, the R&D investments of overconfident CEOs are more productive in generating innovation. However, greater innovative output of overconfident managers is achieved only in innovative industries. We also find evidence that overconfident CEOs are more effective at exploiting growth opportunities and translating them into firm value, especially within innovative industries. We find that overconfidence remains a strong and significant predictor of innovation even when we remove managers with short tenures at their firms, which suggests that the endogenous hiring of overconfident managers by innovative firms is not the main driver of our findings.

The results of this study have a bearing on the usual presumption that overconfidence is undesirable. Business commentators often point to examples of headstrong, overconfident CEOs who made disastrous decisions. However, the chance of a big defeat may be a corollary to the chance of great victory, so the lesson to draw from examples is unclear. A more serious charge is provided by the evidence of Malmendier and Tate (2008) that the market reacts more negatively to acquisitions made by overconfident CEOs. This dark side to CEO overconfidence might seem to suggest that the CEO selection process should be designed to filter out oversized egos, or that compensation and governance should be designed to severely constrain such CEOs.


An “Entrepreneurial” and Restructured SEC Pledges Proactive Enforcement

The following post comes to us from Jonathan Polkes, co-chair of the Securities Litigation Practice Group at Weil, Gotshal & Manges LLP, and is based on a Weil publication by Christian Bartholomew and Sarah Nilson, edited by Mr. Polkes and Mr. Bartholomew. The complete publication, including footnotes, is available here.

At the recent “SEC Speaks” conference in Washington, DC this year, Chairman Mary Schapiro and senior Enforcement officials vowed to increase investor protection through use of the SEC’s expanded authority under the Dodd-Frank Act and initiatives designed to help the SEC enforcement staff proactively detect and prevent securities law violations. In her speech, Schapiro pointed to numerous modernization initiatives as central to this effort, including better hiring, more training, more sophisticated IT systems, and better management structures. Schapiro noted that the Commission now has Wall Street traders, asset managers, and quantitative analysts on staff alongside attorneys, economists and accountants and has more than doubled its training budget since 2009. She also touted the SEC’s new TCR system (tips, complaints, and referrals) as allowing the SEC to better “triage” the information it receives and use that information more effectively in terms of opening new investigations, directing information to existing investigations, and uncovering and tracking emerging trends.

Schapiro pointed to the SEC’s record 735 enforcement actions, which returned more than $2 billion to investors, as evidence that these efforts to modernize the agency and bolster its knowledge base are already bearing fruit. Division of Enforcement Director Robert Khuzami echoed these remarks, saying that the agency’s risk-based initiatives are paying off and that the SEC is being more proactive, which has, in his view, resulted in more deterrence. Declaring a new “entrepreneurial” spirit and ethos, Schapiro and Khuzami made clear that the SEC intends to redouble its enforcement efforts across the board.


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