Monthly Archives: July 2012

Corporate Governance Activism: Here To Stay?

Charles Nathan is of counsel at Latham & Watkins LLP and is co-chair of the firm’s Corporate Governance Task Force. This post is based on a Latham & Watkins Corporate Governance Commentary.

We have been observing the corporate governance movement in the United States for the past several years. Share voting decision makers at most institutional investors inhabit an alternate universe from investment decision makers. [1] Two incompatible economic and philosophical belief systems drive these alternate universes:

  • Investing professionals, overwhelmingly, are rationally apathetic about exercising the voting franchise embedded in stock ownership. [2] Absent a readily observable and positive correlation between exercise of the corporate franchise and creation of shareholder value (as is the case in most M&A votes and proxy contests), investing professionals view the task of making voting decisions on each ballot item for each of their portfolio companies as not merely time consuming and distracting but, worse, economically wasteful. [3]
  • On the other hand, notwithstanding the lack of a demonstrable connection between what is labeled good corporate governance and a positive increase in share valuation, corporate governance advocates continue to maintain that good corporate governance does, in the aggregate, enhance share values. [4] Accordingly, in their view, voting on all ballot issues at each and every portfolio company in order to achieve better corporate governance is a value creator. Starting from this core ideology, corporate governance advocates have successfully persuaded many national politicians, most regulators of the securities and investment industries and virtually all of the financial press, that its so-called corporate governance best practices are an essential requirement for shareholder value creation and that professional investment managers, as a matter of their fiduciary duty to their customers, should be required to vote all portfolio shares on all ballot matters.


Time To Retire Trust Preferred Securities

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.

Recently, the Federal Reserve Board issued a Notice of Proposed Rulemaking (NPR) to implement new capital rules consistent with Basel III, including the Collins Amendment requirement to phase out Tier 1 capital treatment of trust preferred securities (TruPS) for larger institutions. The NPR provides an opportunity for financial institutions to redeem at par many series of expensive TruPS that otherwise remain subject to “make whole” premiums on redemption.

As discussed in our prior memoranda (January 2012 and July 2010), since Dodd-Frank, financial institutions facing loss of Tier 1 treatment for TruPS have been considering  redemption and other means of reducing outstanding TruPS, which carry relatively high interest rates. One obstacle is that TruPS typically require a “make whole premium” above par to redeem in the initial years after issuance. But most TruPS also provide a special redemption right triggered by a “regulatory capital event.” This typically means a company’s reasonable determination that a change, or proposed change, in law or regulation causes a “more than insubstantial risk” of impairment of the issuer’s ability to include the TruPS in Tier 1 capital. There is sometimes a finite window for the redemption call following the event, e.g. 90 days.


The Sources of Value Destruction in Acquisitions by Entrenched Managers

The following post comes to us from Jarrad Harford, Professor of Finance at the University of Washington; and Mark Humphery-Jenner and Ronan Powell, both of the Australian School of Business at the University of New South Wales.

In our paper, The Sources of Value Destruction in Acquisitions by Entrenched Managers, forthcoming in the Journal of Financial Economics, we identify how acquisitions by entrenched managers destroy value. Managerial entrenchment is often seen as worsening corporate governance and facilitating agency-motivated investments. We analyze the role of entrenchment in acquisitions by (not for) entrenched firms. We focus on acquisitions by entrenched managers in order to examine the impact of entrenchment on managerial investments. We find that value-destruction in acquisitions by entrenched acquirers arises for several reasons:

  • Entrenched acquirers disproportionately avoid private targets, which have been shown to be associated with value-creation.
  • If entrenched acquirers do buy an unlisted target (or a public target with a blockholder), they tend not to pay with stock, thereby avoiding the governance benefits that would otherwise accrue from creating a blockholder in the bidder.
  • Entrenched bidders tend to both overpay and acquire low-synergy targets, which manifest in lower combined bidder/target announcement returns and lower post-acquisition operating performance.


Update on Corporate Political Activity

John Coates is the John F. Cogan, Jr. Professor of Law and Economics at Harvard Law School. This post relates to research by Professor Coates discussed on the Forum here, as well as a recent post on a Manhattan Institute Legal Policy Report, discussed here. Work from the Program on Corporate Governance about corporate political spending includes Corporate Political Speech: Who Decides? by Lucian Bebchuk and Robert Jackson, discussed on the Forum here. A committee of law professors co-chaired by Bebchuk and Jackson submitted a rulemaking petition to the SEC concerning corporate political spending; that petition is discussed here.

Corporate politics continue to generate controversy. Recent items of note include (1) the US Supreme Court’s decision to expand the reach of Citizens United in Western Tradition Partnership; (2) the continued increase in the number of and support for shareholder proposals calling for disclosure of corporate political activity; and (3) a recent “study” sponsored by the conservative Manhattan Institute (and described on the Forum here) purporting to find that – as the Wall Street Journal put it – “politics spending pays” – contrary to my own research, which finds that large public companies that were politically active before Citizens United experience a decline in their industry-adjusted market value after the decision. Each of these developments is discussed briefly below.


U.S. Regulators Penalize Fund Advisers

The following post comes to us from Laurence A. Urgenson, partner at Kirkland & Ellis LLP, and is based on a Kirkland Alert by Mr. Urgenson, Laura Fraedrich, Joanna M. Ritcey-Donohue, and Paloma Zepeda.

In recent enforcement actions, fund advisers have run afoul of U.S. regulatory authorities. In a case involving the U.S. Foreign Corrupt Practices Act (“FCPA”), an individual, but not the company, was charged. On the other hand, in a proceeding before the Office of Foreign Assets Control (“OFAC”), a U.S. company was penalized for the action of its non-U.S. agent. Both cases offer lessons for compliance personnel.

1. FCPA: Lessons from Morgan Stanley’s “Rogue” Employee

Former Morgan Stanley employee Gareth Peterson reached a settlement with the U.S. Securities and Exchange Commission (“SEC”) that will permanently bar him from the securities industry, as well as require disgorgement of more than $3 million in cash and real estate the SEC alleges was obtained via violations of the FCPA. [1] In addition to these civil penalties, Peterson will appear for criminal sentencing in June. [2] Peterson may be sentenced to up to five years in prison and ordered to pay up to $250,000, in addition to the civil penalties already paid.

The complaint against Peterson alleges that Peterson made corrupt payments to a Chinese official to secure business for Morgan Stanley’s real estate fund. In what the SEC described as “cross[ing] the line twice,” Peterson then secured part of the investment for himself — so that he could profit personally from the corrupt payment to the Chinese official. [3]


Learning Mores and Board Evaluations

The following post comes to us from Mijntje Lückerath-Rovers, Professor of Corporate Governance at Nyenrode Business University and Director of the Nyenrode Corporate Governance Institute in The Netherlands.

In the paper, Learning Mores and Board Evaluations – Soft Controls in Corporate Governance, which was recently made publicly available on SSRN, I argue that the prevailing boardroom mores, the unwritten rules, are at one end of having an impact on board effectiveness. Legislation, the more tangibly written rules, is at the other end. In between are voluntary codes of conduct, or legally embedded corporate governance codes.

How, without switching to increasing degrees of legislation with hard controls, do we provide direction to desirable conduct in the boardroom and thus to more effective corporate governance? International corporate governance codes were developed in the 1990s in response to declining trust in the financial system and exchange-listed companies. In recent decades, research into corporate governance focused mainly on the design of governance. Corporate governance codes were drawn up with guidelines for executive directors, non-executive directors and shareholders. The requirements in the corporate governance codes were aimed principally at establishing the conditions under which monitoring could be conducted, and less on the actual way in which this monitoring was conducted.


Codifying FINRA’s Front-Running Policy

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

FINRA has proposed to codify its front-running policy, originally adopted by the NASD in 1987, as new FINRA Rule 5270. [1] The new rule would expand the policy to prohibit member firms and their associated persons from engaging in a broader range of front-running transactions ahead of a customer block order in securities. The rule would apply to most derivative transactions, not just those in futures and options, when the block involves the underlying security, as well as to transactions in the block security itself. In addition, block orders subject to the rule would include those in most derivatives, not only futures and options. FINRA believes that the additional trading activity that would now be covered by the broader prohibition would already violate other FINRA rules. The new provisions would also state that front-running activity ahead of non-block orders may violate other FINRA rules or the federal securities laws. FINRA originally proposed these changes in 2008 and expects to announce an implementation date within 90 days after SEC approval.


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