Monthly Archives: September 2012

Second Circuit Opinion on Class Actions Under the Securities Act

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

On September 6, 2012, the United States Court of Appeals for the Second Circuit issued an important decision in NECA-IBEW Health & Welfare Fund v. Goldman Sachs & Co., 11-02762-cv (Sept 6, 2012) (“NECA-IBEW”), vacating in part the dismissal of a putative class action brought under §§ 11, 12(a)(2) and 15 of the Securities Act by an RMBS purchaser. The decision includes important holdings concerning both standing in the class action context and the standard for pleading a cognizable injury under the Securities Act. First, the Court ruled that, in some defined circumstances, purchasers of RMBS certificates have standing to assert claims on behalf of purchasers of certificates in other offerings. Second, the Court held that holders of a security need not allege an out-of-pocket loss to adequately plead damages under Section 11.


A Framework for Board Oversight of Enterprise Risk

The following post comes to us from Gigi Dawe, principal at the Canadian Institute of Chartered Accountants. This post is based on a framework developed by CICA; the full document, including footnotes, is available here.


In the aftermath of financial crises and a global recession, board oversight of enterprise risk continues to be a topical issue for board deliberation. The re-examination of the board’s role in the oversight of enterprise-wide risk has not been limited to investors or boards asking what could have been done to better understand and proactively address exposures. The SEC, New York Stock Exchange and other regulatory bodies continue to examine disclosure requirements related to various forms of enterprise risk. Risk oversight is a high priority for most boards, but for many it is also more-or-less uncharted territory.

What is the appropriate role of the board in corporate risk management? Traditional governance models support the notion that boards cannot and should not be involved in day-to-day risk management. Rather, through their risk oversight role, directors should be able to satisfy themselves that effective risk management processes are in place and functioning effectively. The risk management system should allow management to bring to the board’s attention the company’s material risks and assist the board to understand and evaluate how these risks interrelate, how they may affect the company, and how these risks are being managed. To meaningfully assess those risks, directors require experience, training and knowledge of the business.


Innovation, “Pure Information,” and the SEC Disclosure Paradigm

The following post comes to us from Henry T. C. Hu, Allan Shivers Chair in the Law of Banking and Finance at the University of Texas School of Law.

My article, Too Complex to Depict? Innovation, ‘Pure Information,’ and the SEC Disclosure Paradigm, published in June in the 2012 symposium issue of the Texas Law Review, offers a new conceptualization of the SEC disclosure paradigm that has been in place since the Depression, shows how that paradigm has been undermined by the modern process of financial innovation, and offers possible ways ahead. Since its creation, the SEC’s totemic philosophy has been to promote a robust informational foundation. As a necessary corollary, the SEC’s approach has been incremental, generally not venturing into substantive decision-making (as to stock prices or otherwise).

The article starts by suggesting that this disclosure philosophy has always been largely implemented through what can be conceptualized as an “intermediary depiction” model. An intermediary—e.g., a corporation issuing shares—stands between the investor and an objective reality. The intermediary observes that reality, crafts a depiction of the reality’s pertinent aspects, and transmits the depiction to investors. Securities law directs depictions to be accurate and complete. “Information” is conceived of in terms of, if not equated to, such depictions.


SEC Division of Trading and Markets Issues Guidance on JOBS Act

Giovanni Prezioso is a partner focusing on securities and corporate law matters at Cleary Gottlieb Steen & Hamilton LLP, and former General Counsel of the Securities and Exchange Commission. This post is based on a Cleary Gottlieb memorandum by Leslie Silverman.

On August 22, 2012, the SEC Division of Trading and Markets (the “Staff”) published answers to 14 frequently asked questions (“FAQs”) relating to certain provisions of Title I of the Jumpstart Our Business Startups Act, signed into law on April 5, 2012 (the “JOBS Act”), affecting research analyst and investment banking personnel conduct in connection with emerging growth companies (“EGCs”).

The most noteworthy guidance, in our view, relates to the following:


Dual Class Share Structures: The Next Campaign

Francis H. Byrd is Senior Vice President, Corporate Governance & Risk Practice Leader at Laurel Hill Advisory Group. This post is based on a Laurel Hill newsletter by Mr. Byrd.

The arguments over the merits of dual class share structures have been heating up of late. The issue has resurfaced as institutional investors have complained about the increasing number of IPO companies (Facebook, Groupon, Zynga being the most notable) who have gone public as dual class stock companies limiting the rights and influence of shareholders and turning them into economic bystanders.

One of the stories we cited comes from IR Magazine “CalPERS Strategy Could Avoid IPOs with Dual Class Share Structures” discussing how the fund giant is planning to advocate against the use of dual class structures for companies exiting private equity and entering the public market. Earlier in August, at the ABA Business Section CLE conference, in Chicago, there was a panel discussion on the topic (“Dual Class Stock: Value Enhancer or Corporate Governance Killer?”) The panel comprised of institutional investors, a corporate director (and former investment manager), as well as a corporate attorney and Delaware jurist, all squared off on the issue.


Federal Banking Agencies Publish Federal Register Versions of Capital NPRs

H. Rodgin Cohen is a partner and senior chairman of Sullivan & Cromwell LLP focusing on acquisition, corporate governance, regulatory and securities law matters. This post is based on a Sullivan & Cromwell LLP publication by Andrew Gladin and Mark Welshimer.

On August 30, 2012, the Board of Governors of the Federal Reserve System (the “FRB”), the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation (the “Agencies”) published in the Federal Register three notices of proposed rulemaking (the “NPRs”, and the rules proposed by the NPRs, the “Proposed Rules”) [1] that seek to amend the U.S. risk-based capital rules for banks [2] and implement final amendments to the market risk rules (the “Market Risk Amendments”). Initial versions of the NPRs and the Market Risk Amendments were first issued by the FRB on June 7, 2012 (such initial version of the NPRs, the “Initial NPRs”). [3]

Based on a preliminary review of the NPRs as published in the Federal Register, the Agencies appear to have made few noteworthy changes to the Initial NPRs from June. The changes include:


Allocating Risk Through Contract: Evidence from M&A and Policy Implications

John Coates is the John F. Cogan, Jr. Professor of Law and Economics at Harvard Law School.

Risk allocation provisions (RAPs) are an important part of M&A contracts. In a new research paper, Allocating Risk Through Contract: Evidence from M&A and Policy Implications, I analyze those provisions in the contracts for a representative sample of deals for US targets, and find both wide variation but also clear patterns in when they are used and how they are designed. The patterns I observe reflect multiple economic theories: they show that RAPs are used and designed in light of the information different parties to a deal are likely to have, their incentives during and after the deal, and also transaction costs, especially the costs of enforcing contracts. Despite these patterns, the contracts also show enormous variation in how risk is allocated — and some of this residual variation correlates with the experience of deal lawyers — suggesting that some choices are better than others. Practitioners can benefit from better understanding economic theories, and academics can benefit from better understanding how varied and complex real-world contracts are.

Among the basic patterns I find are the following:


September 2012 Dodd-Frank Progress Report

The following post comes to us from Margaret E. Tahyar and Gabriel D. Rosenberg of the Financial Institutions Group at Davis Polk & Wardwell LLP. This post discusses a Davis Polk report, which is available here. A post about the previous progress report is available here. Other posts about the Dodd-Frank Act are available here.

This posting, the September 2012 Davis Polk Dodd-Frank Progress Report, is one in a series of Davis Polk presentations that illustrate graphically the progress of the rulemaking work that has been done and is yet to occur under the Dodd-Frank Act. The Progress Report has been prepared using data from the Davis Polk Regulatory Tracker™, an online subscription service offered by Davis Polk to help market participants understand the Dodd-Frank Act and follow regulatory developments on a real-time basis. In this report:

  • As of September 4, 2012, a total of 237 Dodd-Frank rulemaking requirement deadlines have passed. Of these 237 passed deadlines, 145 (61.2%) have been missed and 92 (38.8%) have been met with finalized rules.
  • In addition, 131 (32.9%) of the 398 total required rulemakings have been finalized, while 132 (33.2%) rulemaking requirements have not yet been proposed.
  • Major rulemaking activity this month included the Federal Reserve final rule on risk management standards for financial market utilities and the SEC final rules on conflict minerals and the disclosure of payments by resource extraction issuers. Additionally, the OCC, Federal Reserve, NCUA, FHFA and CFPB released a proposed rule on appraisals for higher-risk mortgage loans.

Does Macropru Leak? Evidence from a UK Policy Experiment

The following post comes to us from Shekhar Aiyar, Senior Economist at the International Monetary Fund; Charles Calomiris, Henry Kaufman Professor of Financial Institutions at the Columbia University Graduate School of Business; and Tomasz Wieladek, MPC Adviser, External MPC Unit, Bank of England.

How can governments limit excessive and unstable credit growth? Should they raise capital requirements for banks? In our recent NBER working paper, Does Macropru Leak? Evidence from a UK Policy Experiment, we address these questions using evidence from a policy experiment in the UK. The minimum capital ratio requirements that national regulatory authorities impose on banks have two sets of objectives: (i) so-called ‘micro-prudential’ motives, to ensure the safety and soundness of individual banks; and (ii) ‘macro-prudential’ goals, especially to influence the aggregate supply of credit. Micro-prudential regulation has a long pedigree, but the focus on macro-prudential regulation has increased sharply in the wake of the global financial crisis. This sharpened focus underlies recent changes in the international regulatory regime for banks. Basel III, as the new regime is called, establishes a “countercyclical capital buffer”, under which national regulators would vary banks’ required capital-to-risk-weighted assets ratio over time, thereby helping smooth the credit cycle. For variation in minimum capital requirements to be effective in regulating the aggregate supply of credit, three conditions must be satisfied:


Investing in Good Governance

Editor’s Note: Lucian Bebchuk is a Professor of Law, Economics, and Finance and Director of the Program on Corporate Governance at Harvard Law School. This post is based on an op-ed article by Professor Bebchuk published today in the New York Times DealBook, available here. The op-ed builds on a forthcoming article with Alma Cohen and Charles Wang, titled “Learning and the Disappearing Association Between Governance and Returns.”

The New York Times published today my column Investing in Good Governance. The column discusses a study by Alma Cohen, Charles Wang, and myself about the correlation between governance and returns. The study, Learning and the Disappearing Association between Governance and Returns, forthcoming in the Journal of Financial Economics, is available here.

Earlier research has shown that, during the 1990s, trading strategies based on the Governance Index (Gompers, Ishii, and Metrick (2003)) and the Entrenchment Index (Bebchuk, Cohen, and Ferrell (2009)) would have produced abnormally high returns in the 1990s. Our study shows that the correlation between governance and stock returns in the 1990s did not subsequently persist. The study also provides evidence that both the correlation in the 1990s and its subsequent disappearance were due to market participants’ gradually learning to appreciate the difference between firms scoring well and poorly on the governance indices. Finally, the study establishes that, although the governance indexes could no longer generate abnormal returns in the 2000s, their negative association with operating performance and firm value persists. After discussing these findings, the DealBook column comments on whether there are any ways left for investors to make money from governance.

The DealBook column is available here.

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