Monthly Archives: September 2012

Increasing the Vulnerability of Investors

Editor’s Note: Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on a statement from Commissioner Aguilar; the full statement, 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.

The Commission considered a Congressional mandate to amend our private placement rules, allowing issuers to offer securities by means of general solicitation and general advertising, provided only that all purchasers are accredited investors.

I cannot support the proposal, because it presents a framework that is not balanced and that fails to address the acknowledged increased vulnerability of investors. In fact, there is no consideration of any of the commenters’ proposals that would have decreased investor vulnerability.


SEC Adopts Final Conflict Minerals Rules

Richard J. Sandler is a partner at Davis Polk & Wardwell LLP and co-head of the firm’s global corporate governance group. This post is based on a Davis Polk client memorandum, available here.

The SEC voted to implement the Dodd-Frank Act’s reporting requirements relating to “conflict minerals” — cassiterite, columbite-tantalite, gold, wolframite and other minerals determined by the U.S. government to be financing conflict in the Democratic Republic of Congo or adjoining countries, referred to as the “DRC countries” or “covered countries.” Companies must comply with the final rules for the calendar year beginning January 1, 2013 with the first reports due May 31, 2014.

The final rules adopted contain substantial changes from the SEC’s original proposal in December 2010. Below is a summary of the changes. We will provide a more in-depth analysis of the rules once we have fully analyzed the adopting release.


The Labor Market for Directors, Reputational Concerns, and Externalities

The following post comes to us from Doron Levit of the Department of Finance at the University of Pennsylvania and Nadya Malenko of the Department of Finance at Boston College.

In the paper, The Labor Market for Directors, Reputational Concerns, and Externalities in Corporate Governance, which was recently made publicly available on SSRN, we examine how the labor market for directors and directors’ reputational concerns affect corporate governance.

Being a director on the board of a public company is a privilege that often brings generous monetary compensation, prestige, publicity, power, and access to valuable networks. In order to retain old board seats and gain new ones, directors need to develop a reputation and prove they are a good match for other companies. However, it is not clear what reputation is “relevant” in this context. If corporate governance is strong and boards of other companies protect the interests of their shareholders, then building a reputation for being shareholder-friendly can help in obtaining more directorships. On the other hand, if corporate governance is weak and boards of other companies are captured by their managers who want to maintain power, then having a reputation for being management-friendly might be more useful. The goal of this paper is to understand how the labor market for directors and these conflicting reputational concerns affect directors’ behavior and the quality of corporate governance.


The SEC Punts (Again) on Financial Stability Reform

Editor’s Note: Jeffrey Gordon is the Richard Paul Richman Professor of Law and Co-Director of the Center for Law and Economics at Columbia Law School.

In an all-too-familiar pattern, the SEC has backed down in the face of industry pressure and dropped a key proposal to prevent a repetition of the 2008 financial crisis. Despite valiant efforts by Chair Mary Shapiro, a divided Commission has rejected further steps toward reform of money market funds, a $3 trillion dollar financial intermediary that was at ground zero of the financial crisis and that now presents a continuing threat to financial system stability.

A powerful industry group, mutual funds and some of their clients, have persuaded three SEC Commissioners to ignore the near implosion of the money market fund sector in 2008. Here are their names, for now is an accountability moment: Luis A. Aguilar, Daniel M. Gallagher, and Troy A. Parades.


Board Engagement with Corporate Shareholders

Jeffrey Stein is a partner in the Corporate Practice Group at King & Spalding LLP. This post is based on a report from the Lead Director Network by Mr. Stein, Bill Baxley, and Rob Leclerc, available here.

Historically, there has been little direct dialogue between individual board members and shareholders. This is changing, however, as directors, particularly lead directors, face increasing pressure to meet directly with their companies’ largest shareholders. Accordingly, at many companies, individual directors are beginning to engage with investors on an ongoing basis, and not just in response to a particular issue or crisis.

The Lead Director Network (the “LDN”), a group of lead directors, presiding directors and non-executive chairmen from many of America’s leading companies, met on June 19, 2012 to discuss the relationship between directors and major shareholders. Representatives of two institutional investors also participated in the meeting. Following this meeting, King & Spalding and Tapestry Networks have published a ViewPoints report here to present highlights of the discussion that occurred at the meeting and to stimulate further consideration of this subject.

The following provides highlights from the LDN meeting, as described in the ViewPoints report.


PCAOB Adopts New Audit Standard on Communications with Audit Committees

John Olson is a founding partner of Gibson, Dunn & Crutcher’s Washington, D.C. office and a visiting professor at the Georgetown Law Center. This post is based on a Gibson Dunn alert by Gillian McPhee and Michael Scanlon.

At an open meeting held on August 15, 2012, the Public Company Accounting Oversight Board (“PCAOB”) voted to approve new Auditing Standard No. 16, Communications with Audit Committees. Although the new standard retains most of the preexisting communication requirements, there are a number of new areas that the auditor must discuss with the audit committee, and there are some areas where the auditor must seek specific responses from the audit committee. The new standard, available at, is intended to benefit investors by enhancing the relevance and quality of communications between the auditor and audit committee, facilitating audit committee oversight of financial reporting and fostering improved financial reporting.

Background and Effective Dates

The PCAOB initially proposed Auditing Standard No. 16 for comment in March 2010 and issued a revised proposal in December 2011 following an initial comment period and feedback received at a September 2010 roundtable. Auditing Standard No. 16 expands on and supersedes existing standards on communications with audit committees (interim standards AU sec. 380, Communication With Audit Committees, and AU sec. 310, Appointment of the Independent Auditor), and makes conforming changes to related standards. The new standard requires SEC approval and, if approved, will apply to audits of public company financial statements for fiscal years beginning on or after December 15, 2012.

Auditing Standard No. 16 is the first standard that the PCAOB has adopted following enactment of the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). Under the JOBS Act, a new PCAOB standard will not apply to audits of “emerging growth companies” (“EGCs”) unless the SEC determines that the application of the standard is “necessary or appropriate in the public interest, after considering the protection of investors and whether the action will promote efficiency, competition, and capital formation.” At its August 15 meeting, the PCAOB expressed its view that the SEC should approve the application of the new standard to EGCs.


Does the Gender of Directors Matter?

The following post comes to us from Miriam Schwartz-Ziv of the Department of Finance and Banking at the Hebrew University of Jerusalem.

In the paper, Does the Gender of Directors Matter?, which was recently made publicly available on SSRN, I investigate how having gender-balanced boards affects the working of boards. There has always been interest in the makeup of boards of directors, both in the academic literature and in the popular press. Lately, board diversity, and particularly the gender of directors has been a topic of much attention, since there is a recent movement to impose diversity requirements on boards. In the United States, the Securities Exchange Commission requires that companies disclose whether they have a diversity policy, and how it applies to board recruitment practices (Regulation S-K, Item 407(c)). In Europe, several countries (including Norway, France, Spain, and Italy) have already legislated laws enforcing gender quotas. Furthermore, Dr. Viviane Reding, the vice president of the European Commission, is promoting legislation enforcing gender quotas in all European countries (New York Times, March 4th, 2012).

Despite this attention, it nonetheless remains unclear whether diversity has a meaningful impact upon boards of directors, and how such impact might be measured. As emphasized by Hermalin and Weisbach (2003), board composition is jointly determined with firm performance, so it is problematic to draw inferences from the associations between firm performance and board composition. These scholars argue that instead of looking at the impact of boards on a firm’s overall financial performance, it is better to understand the impact of board composition by considering how it affects the actions the board or the firm take, given the board composition at the time the action is taken.


Forest Laboratories Proxy Fight Vindicates Strong Defense

Andrew R. Brownstein is a partner in the Corporate Department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Brownstein, Igor Kirman, and William Savitt.

Forest Laboratories’ shareholders reelected nine out of ten incumbent director nominees, while rejecting three out of dissident Carl Icahn’s slate of four directors, despite ISS’s recommendation in favor of two of Icahn’s nominees. These results, along with the recent victory by AOL against Starboard (see our memo, AOL Shareholders Reject ISS Supported Activist Hedge Fund), represent an important reminder that companies under attack by dissidents have a chance to defend themselves with a well-crafted message that articulates a strategy for long-term success, notwithstanding strong activist pressure with backing from ISS.


Corporate Director Elections and Majority Withhold Votes

The following post comes to us from Richard Bennett, Chairman of GovernanceMetrics International, and is based on a GMI Ratings study by Kimberly Gladman, Agnes Grunfeld and Michelle Lamb, available here.

Executive Summary

In theory, the most significant corporate governance check and balance between public company shareowners and the company is the ability to elect corporate directors. In reality, that control mechanism is complicated and often compromised for a host of reasons. Nonetheless, there has been an increased focus on director elections in the past few years. This study examines what happens when shareowners withhold a majority of votes from a director nominee.

The significance of majority withhold votes for corporate directors is the subject of some debate in the governance and business community. It is sometimes argued that majority withhold votes are of little import because they are infrequent, rarely lead to director resignations, and typically come in response not to corporate-specific failings, but to violations of perceived best practice (such as the adoption of a poison pill without shareholder approval). At the same time, however, some academic literature has suggested that high levels of withhold votes may be an indicator of generally negative market perceptions of a company. [1]

This current report contributes to this discussion through an examination of majority withhold votes for 175 director nominees at Russell 3000 companies between July 1, 2009 and June 30, 2012. On the one hand, the study confirms that withhold votes occur at a small percentage of companies, and lead to director resignations in only a small proportion of cases. However, we also find that only about half of majority withhold votes are related to best practice issues, and nearly a fifth co-occur with other serious evidence of shareholder dissatisfaction. Our study also examines corporate disclosures regarding board response to majority withhold votes. We find that companies with majority or plurality plus resignation standards for director elections are more likely to make informative disclosures than those with plurality standards. [2] An analysis of withhold votes in connection to financial performance was inconclusive, but suggests directions for further study of this relationship.


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