Monthly Archives: July 2012

EU Prospectus Directive: Amendment Update

Eduardo Gallardo is a partner focusing on mergers and acquisitions at Gibson, Dunn & Crutcher LLP. This post is based on a Gibson Dunn client alert by Jeffery Roberts, Edward Tran, and Lisa Stevens.

The prospectus regime is being amended throughout Europe and this Alert provides (i) a summary of the key provisions of Directive 2010/73/EU (the “Amending Directive”), which amends the Prospectus Directive 2003/71/EC (the “Prospectus Directive”), and (ii) details of the related recently published delegated amending regulations, which amend the Prospectus Regulation 809/2009 (the “Prospectus Regulation”). Some of these changes have already been implemented in the UK and others will come into force on 1 July 2012.

These changes will modify:

  • when the Prospectus Directive does not apply;
  • when a prospectus which complies with the Prospectus Directive (a “Prospectus”) must be published;
  • requirements in relation to the form and content of a Prospectus; and
  • certain other aspects of Prospectus regulation.


Compensation Committees and Adviser Independence under Dodd-Frank

Victor Lewkow is a partner at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum by Mary Alcock and Helen Skinner.

On June 20, 2012, the U.S. Securities and Exchange Commission (the “SEC”) released its final rules (the “Final Rules”) implementing Section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). Section 952 of the Dodd-Frank Act (“Section 952”) added Section 10C to the Securities Exchange Act of 1934 (the “Exchange Act”) and contains a number of provisions generally relating to the independence of compensation committees and their advisers. The Final Rules are in most respects identical to the proposed rules released on March 30, 2011 (the “Proposed Rules”). [1] Below is a summary of the provisions of the Final Rules, noting the key changes from the Proposed Rules.


New Basel Disclosure Rules

The following post comes to us from Charles Horn and Dwight Smith, partners focusing on bank regulatory matters at Morrison & Foerster LLP, and is based on a Morrison & Foerster memorandum by Mr. Horn and Mr. Smith.

Yesterday, the Basel Committee on Banking Supervision published its Compilation of Capital Disclosure Requirements (“Disclosure Rules”) setting forth a uniform scheme for Basel II banks to disclose the composition of their regulatory capital. These rules are intended to be implemented by national supervisors by June 30, 2013, and affected banks will be expected to comply with all but one of the new requirements for any balance sheet financial statements published after that date. One fully phased-in requirement, a “common disclosure template,” becomes effective on and after January 1, 2018.

In announcing these rules, the Basel Committee noted that the financial crisis revealed the difficulties that market participants and national supervisors had in their efforts to undertake detailed assessments of banks’ capital positions and make cross-jurisdictional comparisons, as a result of “insufficiently detailed disclosure” by banks and a lack of consistency in reporting between banks and across jurisdictions. The Disclosure Rules are intended to address these perceived disclosure deficiencies, and promote uniform and meaningful capital disclosures within and across national jurisdictions.

Basel II banks in the United States can expect future banking agency rulemaking to implement the Disclosure Rules. These rules presumably will be integrated with the disclosure provisions in the new capital and resolution planning regulations. Review of yesterday’s announcement should not be limited to Basel II banks in the United States, however; as with other Basel standards, the Disclosure Rules may lead to new disclosure requirements for a large number of non-Basel II banks in the U.S.


Managing Agency Problems in Early Shareholder Capitalism

The following post comes to us from Paul Ingram, Professor of Business at Columbia University, and Brian Silverman, Professor of Strategic Management at the University of Toronto.

In the paper, Managing Agency Problems in Early Shareholder Capitalism: An Exploration of Liverpool Shipping in the 18th Century, which was recently made publicly available on SSRN, we use historical data on Liverpool transatlantic shipping to examine the effect of equity ownership on top manager behavior. We found that the pattern of equity ownership by captains in the vessels that they piloted was not random. Rather, vessels that were at particular risk of attack by enemy privateers were significantly more likely to have captains who were also part-owners. This is consistent with an agency view of equity ownership. Owners preferred that captains resist privateers fiercely, but it was difficult to construct contractual incentives to elicit such behavior. Partial ownership of the vessel by the captain was one mechanism by which to align captains’ and owners’ incentives regarding the privateer threat, and consequently to elicit desired behavior from captains.

We found that equity ownership was associated with a lower likelihood that a vessel would be captured by privateers. Difference of means tests indicated a statistically significant reduction. Multivariate estimation indicated a stable, negative effect of captain-ownership on the likelihood of being captured by privateers, although the statistical significance of this relation-ship varied across models. Overall, the use of equity ownership by Liverpool vessel owners, and the effect of equity ownership on vessel captains’ behavior, appears to be largely consistent with agency theory’s predictions about the modern use and effect of equity on shareholder and top management behavior.


SEC Settlement Trends

Elaine Buckberg is Senior Vice President at NERA Economic Consulting. This post is based on a NERA publication by Ms. Buckberg and James A. Overdahl; the full publication (including charts and footnotes) is available here.

Trends in the Number of Settlements

The SEC’s promise to hold more individuals accountable was realized in 1H12 in a 20% jump in the number of SEC settlements with individuals. The SEC settled 286 cases with individuals in the first half of this year, putting it on pace for 572 settlements in FY12, which would be the most since 2005. This marks a shift from the end of fiscal 2011, when we reported that the SEC’s promise to hold more individuals accountable was borne out in the value, but not in the number, of settlements with individuals.

Total SEC settlements are also up, but the increase is entirely explained by the rise in settlements with individuals. The SEC settled with 379 defendants in 1H12, putting it on pace for 758 settlements in FY12. This would constitute a 13% increase from the SEC’s 670 settlements in 2011 and would constitute the most annual settlements since 2005. The pace of settlements with companies is down slightly, with 93 settlements, consistent with an annual pace of 186, as compared with 196 in FY11.

The increase in individual settlements is driven primarily by allegations relating to insider trading. The increase from 63 insider trading settlements in FY11 to an annualized number of 120 projected for FY12 accounts for over half of the observed increase in settlements in 2012. The SEC also increased its settlement activity with individuals in matters relating to Ponzi schemes. Settlements with individuals relating to public company misstatements rose to an annualized pace of 78 settlements, up from a low of 60 in 2011, but still well below the 91 settlements in 2010.


Say on Pay 2012

Jeremy Goldstein is a partner at Wachtell, Lipton, Rosen & Katz active in the firm’s Executive Compensation and Benefits practice. This post is based on a Wachtell Lipton firm memorandum by Mr. Goldstein, Michael J. Segal, and Jeannemarie O’Brien.

The following are our observations on the second year of mandatory “say on pay” votes for U.S. public companies under Dodd-Frank thus far this proxy season.

Results of Vote. As of June 25, 2012, of the companies that have reported results for 2012, 54 have failed their say on pay votes. This is an increase from 2011 and there remain a number of companies left to report. Four companies have failed two years in a row. 396 companies in the S&P 500 have reported say on pay results as of June 22, 2012, of which 384 received majority shareholder support (97%). Similar to last year, the mean level of shareholder approval is 89% and the median level of shareholder approval is 95%.

Influence of ISS. The recommendation of ISS continues to have a measurable impact on voting results. ISS has recommended against say on pay proposals at approximately 14% of the S&P 500 companies as of June 22, 2012. Of companies receiving unfavorable vote recommendations from ISS, 21% of those that had reported results as of June 22, 2012 failed to receive majority support. Companies receiving negative ISS recommendations that have nonetheless received majority support have generally done so with considerably lower margins than those receiving a favorable ISS recommendation. According to a recent study by Pay Governance, a negative ISS recommendation results in an average shareholder support level of 65% versus 95% for those receiving a positive ISS recommendation (for S&P 500 companies, the difference in support levels based on such recommendations is 59% versus 94%). According to the same study, this is a 10% increase over last year’s correlation. During the approximately two years of mandatory say on pay proposals under Dodd-Frank, only one company that received a positive ISS recommendation failed to receive majority shareholder support. The median change in voting results following a year-over-year change in ISS recommendation is approximately 27%.


The Costs of a Combined Chair/CEO

The following post comes to us from Paul Hodgson, Chief Communications Officer and Senior Research Associate at GovernanceMetrics International, and is based on a GMI report by Mr. Hodgson and Greg Ruel.

The two most authoritative positions in a boardroom are the CEO and the chairman. However, when these roles are combined, all the authority is vested in one individual; there are no checks and balances, and no balance of power. The CEO is charged with monitoring him or herself, presenting an obvious conflict of interest. Indeed, if the CEO is responsible for running the company, and the board is tasked with overseeing the CEO’s decisions in the interests of shareholders, how can the board properly monitor the CEO’s conduct if he or she is also serving as board chair?

While the theory behind separating the two roles has been the subject of much shareholder and governance activist protest and commentary, an analysis of GMI Ratings’ data suggests that other, more practical considerations would support the separation of the two roles. In addition to the inherent conflict of interest already discussed, CEOs who also command the title of chairman are more expensive than their counterparts serving solely as CEO. In fact, executives with a joint role of chairman and CEO are paid more than even the combined cost of a CEO and a separate chairman. Also, companies with a combined CEO and chairman appear to present a greater risk of ESG (environmental, social and governance) and accounting risk than companies that separate the roles. Furthermore, companies with combined CEOs and chairmen also appear to present a greater risk for investors and provide lower stock returns over the longer term than companies that have separated the roles. Thus having a separate chairman and CEO costs less, is less risky and is a better investment. This report focuses on 180 North American mega-caps, those with a market capitalization of $20 billion or more. This group was chosen because, given the relative complexity of running the companies, it might be expected that the resulting differentials between leadership structures in cost structure, performance and risk exposure would be more marked. Here are some of the main findings of the report:


Pension Funds as Owners and Investors

Editor’s Note: Luis A. Aguilar is a commissioner at the U.S. Securities and Exchange Commission. This post is based on a Commissioner Aguilar’s keynote address before the NAPPA 2012 Legal Education Conference; the full address, including footnotes, is available here. 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.

As an SEC Commissioner focused on investor protection, I’d like to talk to you today about some issues important to investors in the current capital market environment, and how public pension funds, in their capacity as shareowners and investors, can be a more effective voice for America’s working families.

Investors are the Capital Providers — The Economic Impact of Public Pension Funds

First, I want to quickly highlight the critical role public pension plans have in our economy. As they often do, the statistics tell the story: State and local pension plans serve about 14.4 million active employees, and pay benefits to about 7.5 million current beneficiaries. In 2010, public pensions paid an average benefit of just under $26,000 per year. That regular income provides security, stability and peace of mind that individual savings and defined contribution plans alone cannot ensure for most workers.

Pension plans may also help reduce the disparity in retirement incomes between men and women, as well as the wide income gulf between white and non-white households in retirement. A 2009 report by the National Institute on Retirement Security found that, while older households headed by women, and those headed by people of color, were significantly more likely to be classified as poor than their male and/or white counterparts, that disparity is substantially reduced among households receiving pension income.


Multinationals and the High Cash Holdings Puzzle

The following post comes to us from Lee Pinkowitz of the Department of Finance at Georgetown University; René Stulz, Professor of Finance at Ohio State University; and Rohan Williamson, Professor of Finance at Georgetown University.

In the paper, Multinationals and the High Cash Holdings Puzzle, which was recently made publicly available on SSRN, we investigate whether the cash holdings of American companies are abnormally high after the financial crisis and whether these cash holdings can be explained by the theories summarized in the previous paragraph. We show that the extent to which cash holdings are unusually high after the crisis depends critically on the measure used. We would expect larger firms to hold more cash. Since corporate assets tend to grow over time, the dollar amount of cash holdings would grow even if the ratio of cash to assets stays constant. Consequently, at the very least, cash holdings should be measured relative to a firm’s assets. Using all non-financial and non-regulated public firms with assets and market capitalization greater than $5 million per year, the average cash/assets ratio is 20.18% in 2009-2010 compared to 20.50% in the 2004-2006 pre-crisis period. However, when we consider the median ratio, it is higher by 0.87% in 2009-2010 than in 2004-2006. Similarly, the asset-weighted ratio is higher by 0.74% in the recent period. The larger increase in the asset-weighted ratio than in the equally-weighted ratio suggests that large firms increased their holdings more and we show that this is the case. However, the changes in cash holdings from 2004-2006 to 2009-2010 are dwarfed by the changes in cash holdings from 1998-2000 to 2004-2006. Over that latter period, the average cash/assets ratio increases by 3.77%, the median by 6.39%, and the asset-weighted average by 3.62%. When we distinguish between private and public firms, we show that there is no evidence of an increase in the cash/assets ratio for private firms.


Hedging Under the Volcker Rule

Hal Scott is the director of the Program on International Financial Systems at Harvard Law School and the director of the Committee on Capital Markets Regulation. This post is based on a statement from the committee, available here.

Debate continues around the proposed regulations to implement the Volcker Rule, most lately around its provisions related to permitted hedging activities. As the Committee on Capital Markets Regulation (CCMR) has commented in the past, the proposed regulations should be appropriately constructed to address activities that are specifically permitted under Dodd-Frank, including market-making, underwriting and hedging.

Following the recent JPMorgan (JPM) trading losses, some have called for tightening or even removing the provisions for portfolio hedging that are incorporated in the proposed regulations. Dodd-Frank permits hedging on aggregated positions but critics suggest this should not be interpreted to allow hedging on a portfolio basis. Despite the JPM losses, however, CCMR believes that portfolio hedging should in general be permitted.

Portfolio hedges are crucial for banks to reduce overall volatility and risk. Overly restricting hedging would actually increase bank risk, the very outcome the critics themselves seek to avoid. Suggestions that portfolio hedges need to be correlated to individual underlying positions are both unworkable and overlook the reality that banks seek to hedge their overall mix of assets, and potential movements across an entire portfolio, rather than single movements of individual assets. Furthermore, correlations evolve over time and hedging is a dynamic process.


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