Monthly Archives: May 2012

The Clearing House Association Issues Draft Governance Principles

Michael M. Wiseman is managing partner of the Financial Institutions Group at Sullivan & Cromwell LLP. This post discusses the Guiding Principles for Banking Organization Corporate Governance, developed by the Clearing House, available here (with an introductory memorandum from Sullivan & Cromwell). Mr. Wiseman and Sullivan & Cromwell acted as advisers to the Clearing House, but the views expressed here are his and do not necessarily represent those of the Clearing House or the drafters.

The corporate governance of banking organizations has become the focus of intense examination in the wake of the financial crisis. Because of the complexity that surrounds both the causes of the financial crisis and the weaknesses and vulnerabilities it exposed in the banking system and financial markets, it is manifestly unreasonable to suggest that better corporate governance practices at banking organizations alone could have prevented, or even substantially ameliorated, the crisis. That said, good corporate governance, including a well-functioning board of directors, is critical to a financial institution’s ability to manage its risks prudently, while operating profitably and contributing to economic growth.

In recognition of the importance of good corporate governance in the banking system, the Clearing House, an association comprised of some of the world’s largest commercial banks, has developed and submitted for public comment its Guiding Principles for Banking Organization Corporate Governance (the “Guidelines”). These principles focus on the role of the board of directors, as a cornerstone of the governance structure.

The U.S. banking system is unusual in that banking organizations in the United States, especially larger ones, are typically organized in a bank holding company structure. There is a holding company, organized as an ordinary business corporation, as the top-tier entity, which in turn owns one or more commercial banks and other operating subsidiaries. The Guidelines address governance at both the top-tier entity and bank subsidiary levels, but recognize that many risk management and governance issues may be best addressed on an organization-wide basis at the top-tier entity level.


Unique Issues Facing Companies Under the STOCK Act

The following post comes to us from Kenneth A. Gross, leader of the Political Law Practice at Skadden, Arps, Slate, Meagher & Flom LLP, and is based on a Skadden, Arps memorandum.

On April 4, 2012, President Obama signed the Stop Trading on Congressional Knowledge Act (the “STOCK Act”), and the House Committee on Ethics issued the first set of guidance under the STOCK Act (see memorandum). Among other things, the STOCK Act confirms that Congressional Members and staff, and federal executive and judicial branch officials, owe a duty with respect to material, nonpublic information derived from the person’s position with the federal government under the insider trading provisions in Section 10(b) of the ’34 Act and related SEC Rule 10b-5. In other words, information held by such federal officials qualifies as inside information upon which an insider trading case can be based if it is shared. Although much has been said as to when a federal official can be liable as a “tipper” in an insider trading case, the following focuses on the “tippee” liability that can accrue to the company with which the official shares such information.

A company’s tippee liability is derivative of the tipper’s liability; that is, a tippee will not be found liable unless the tipper is found to be liable. For a tipper to be liable, he or she must (1) disclose material, nonpublic information to the tippee in breach of his or her fiduciary duty and (2) receive a personal benefit as a result of the disclosure. While the interpretation by the courts of “personal benefit” has not been consistent, it is important to note that a number of courts have broadly interpreted this requirement, for example finding the passing of information to maintain goodwill with the tippee sufficient to meet the test. If the elements of tipper liability are satisfied, tippees can be held liable if the tippee (1) acts on the information, and (2) knows, or reasonably should know, that the tipper’s disclosure is in breach of his or her fiduciary duty.


The JOBS Act: Implications for Private Company Acquisitions and M&A Professionals

George Bason is the global head of the mergers and acquisitions practice at Davis Polk & Wardwell LLP. This post is based on a Davis Polk client memorandum by Mr. Bason, John D. Amorosi, William M. Kelly, Mischa Travers, and Richard D. Truesdell.

On April 5, President Obama signed into law the Jumpstart Our Business Startups Act (the “JOBS Act”), which as we’ve previously noted represents a very significant loosening of restrictions around the IPO process and post-IPO reporting obligations. While most of the commentary on this legislation has thus far focused on its impact on capital markets matters, there are implications for private company mergers and acquisitions as well.

Late-stage private companies contemplating an M&A or IPO exit often undertake so-called “dual-track” processes in which they simultaneously file an IPO registration statement with the SEC and hold discussions with prospective acquirors.  The IPO side of the process effectively becomes a stalking horse for M&A discussions and tends to force the hand of prospective acquirors that might otherwise not move as quickly as the target would like.  The publicly filed registration statement both attracts attention and provides prospective acquirors with a sort of first-stage diligence that theoretically helps encourage bids.

Under the JOBS Act, emerging growth companies or “EGCs” will now have the ability to file their registration statements confidentially, so long as the confidential filings are ultimately released at least 21 days before the road show.  Whether confidential filings will become the norm remains to be seen; there are a number of reasons why an IPO candidate might want to continue to use the traditional public filing process, including the publicity, customer and employee-related benefits of having a highly visible registration statement.  For many companies, however, these benefits will be outweighed by the competitive advantages of keeping early filings confidential.  The optionality that confidential filings create may be hard to resist: A confidential filer can now pull its deal without the stigma associated with withdrawing a publicly filed registration statement.


Equity-Holding Institutional Lenders

The following post comes to us from Michael Weisbach and Bernadette Minton, both of the Department of Finance at The Ohio State University, and Jongha Lim of the Department of Finance at the University of Missouri.

In our paper, Equity-Holding Institutional Lenders: Do They Receive Better Terms?, which was recently made publicly available on SSRN, we evaluate the way in which institutional equity holders are involved in the lending process. Participation by equity-holding institutions has become a major part of the syndicated loan market. In our sample of 11,137 institutional “leveraged” loan tranches between 1997 and 2007 from the DealScan database, 2,008 (18%) have participation by a “dual holder” institution that owns at least 0.1% of the borrowing firm’s equity. Lending to firms in which one has an equity position goes against the principle of diversification, since it exposes the investor to firm-specific shocks through both its equity and debt ownership. To justify dual holding, the investor must receive compensation of some sort, either through the improvements in the value of its equity holdings, or by above market rates of return on the loan.

We estimate the abnormal return a dual holder receives by comparing spreads on dual holder tranches to those on observationally equivalent tranches that do not have a dual holder. Our estimates indicate, holding all else equal, that loan tranches with dual holder participation receive a 13 basis-point higher spread than otherwise similar tranches without an equity holder’s participation in the lending syndicate. The positive spread is statistically and economically significant for revolvers as well as term loans and for loans to borrowers of different ratings and to unrated borrowers as well.


Limits on Extraterritorial Reach of State Law

George Conway is partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum from Mr. Conway, Herbert M. Wachtell, Ben M. Germana, and Graham W. Meli.

Recently, in Global Reinsurance Corp.–U.S. Branch v. Equitas Ltd., the New York Court of Appeals, New York’s highest court, refused to apply the state’s antitrust statute, the Donnelly Act, to allegedly anticompetitive conduct in Great Britain that had only incidental effects in New York.  Reversing a divided decision of the intermediate appellate court, the Court of Appeals reasoned that state antitrust law could not have a broader extraterritorial reach than federal antitrust law; otherwise, statutory and judicial limitations on the federal Sherman Act “would be undone if states remained free to authorize ‘little Sherman Act’ claims that went beyond it.”

This rationale may have significant implications beyond the antitrust arena, as the Court of Appeals more broadly reaffirmed that “[t]he established presumption is, of course, against the extra-territorial operation of New York law.”  For example, the potential impact on securities claims under state common law is particularly notable.  In the wake of the United States Supreme Court’s decision in Morrison v. National Australia Bank, which held that Section 10(b) of the Securities Exchange Act applies only to domestic securities transactions (see our memo here), a number of plaintiffs have attempted to invoke state common law to recover losses on extraterritorial transactions.  One potential obstacle to such state-law suits appeared to have been removed late last year, when the Court of Appeals, in Assured Guaranty (UK) Ltd. v. J.P. Morgan Investment Management, rejected a line of lower-court and federal precedents that had held common-law securities actions preempted by New York’s securities statute, the Martin Act (see our memo here).


New PCAOB Auditing Standards

The following post comes to us from Robert Buckholz, partner and co-coordinator of the Corporate and Finance Group at Sullivan & Cromwell LLP. This post is based on a Sullivan & Cromwell publication.

The Public Company Accounting Oversight Board is proposing a new auditing standard that relates to the auditor’s evaluation of a company’s relationships and transactions with related parties, and amendments to existing auditing standards that relate to significant unusual transactions and financial relationships and transactions by a company with its executive officers (including incentive compensation arrangements). The new and amended standards are intended to focus auditors’ efforts on areas that may pose an increased risk of material misstatement to a company’s financial statements.

The PCAOB’s proposals largely build upon and enhance existing requirements in these areas, primarily by providing greater specificity around the procedures that must be employed and inquiries that must be made. While the proposals would not directly impact the non-financial-statement disclosure (such as proxy disclosure) relating to related party transactions and executive compensation under SEC rules, companies should anticipate greater auditor focus and additional audit procedures on the financial statement impact of these areas if these proposals are adopted.

Subject to SEC approval, the new and amended standards would be effective for audits of financial statements for fiscal years beginning on or after December 15, 2012. The deadline for public comment is May 15, 2012.


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