Monthly Archives: October 2012

A Capital Market, Corporate Law Approach to Creditor Conduct

Mark Roe is the David Berg Professor of Law at Harvard Law School, where he teaches bankruptcy and corporate law.

Earlier in October, Federico Cenzi Venezze and I posted “A Capital Market, Corporate Law Approach to Creditor Conduct” up on SSRN. Michigan Law Review is scheduled to publish the article in their next volume.

In this article, we focus on the problem of creditor conduct in distressed firms — for which policymakers ought to have the economically-sensible repositioning of the distressed firm as a central goal. This problem has vexed courts for decades, without coming to a stable doctrinal resolution. It’s easy to see why developing an appropriate rule here has been difficult to achieve: A rule that facilitates creditor operational intervention going beyond ordinary collection on a defaulted loan can induce creditors to intervene perniciously, to shift value to themselves. But a rule that confines creditors to no more than collecting their debt can allow failed managers to continue mismanaging the distressed firm, with the only real alternative to the failed incumbent management — the creditor — being paralyzed by unclear and inconsistent judicial doctrine.

The article proceeds in four steps. For the first step, we show that existing doctrines do not address themselves to facilitating efficacious management of the failing firms. Yet with corporate and economic volatility as important as ever, courts should seek to make doctrine here more functionally-oriented than it now is.


International Coordination Among Regulators

Editor’s Note: Elisse B. Walter is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Walter’s remarks to the American Bar Association International Section, available here. The views expressed in this post are those of Commissioner Walter and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

As you may know, I am the Commission’s designated representative on the Financial Stability Board, or FSB, which is an international forum of prudential financial regulators, market regulators, international financial institutions and standard setting bodies. And last spring I finished a tour of duty as the Commission’s head of delegation to the International Organization of Securities Commissions, also known as IOSCO, a position now ably filled by the Commission’s Director of the Office of International Affairs, Ethiopis Tafara. The experience I have had representing the Commission in these institutions has been enlightening. While I, like most people, already understood that we are living in an increasingly interconnected world, serving on IOSCO and the FSB has helped me better appreciate the extent of these connections in the financial system, as well as both the power and the limitations of these international forums.

One of the better-known achievements of IOSCO is how it has increased international cooperation among securities regulators in the area of enforcement. This cooperation has been extraordinarily valuable, facilitating countless Commission cases where crucial evidence rests outside of the United States. Building on this success, we are now establishing cooperative arrangements with other regulators in our supervision program.


The Most Influential People in Corporate Governance

Each year, the National Association of Corporate Directors’ Directorship magazine publishes the Directorship 100 list, which seeks to identify “the most influential people in the boardroom community, including directors, corporate governance experts, journalists, regulators, academics and counselors.” A review of this year’s list indicates that, as in prior years, individuals affiliated with Harvard Law School and its Program on Corporate Governance play a central role in the corporate governance landscape.

This year’s Directorship 100 list includes 39 individuals who are Harvard Law School faculty or fellows, guest contributors to the Forum on Corporate Governance and Financial Regulation, and/or Harvard Law School alumni. The “Harvard 39” (with graduation year in parenthesis for those who are HLS alumni) are as follows:

The full Directorship 100 list is available here.

Delaware Court of Chancery Dismisses Hastily Filed Caremark Action

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 Mr. Gallardo, Brian Lutz, James Hallowell, and Jefferson Bell. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

On September 25, 2012, Vice Chancellor Travis Laster of the Court of Chancery of the State of Delaware dismissed the derivative complaint in South v. Baker, C.A. No. 7294-VCL, with prejudice. This decision reaffirms the Chancery Court’s low tolerance for hastily filed shareholder derivative lawsuits brought under the In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996), line of cases where the plaintiff makes little effort to plead any connection between a “corporate trauma” and the conduct of a board of directors. At the same time, the South decision also finds that shareholders are entitled to, and should seek, books and records from Delaware corporations before bringing derivative lawsuits in Delaware. Accordingly, Delaware corporations should anticipate an increase in shareholder demands for books and records under Section 220 of the Delaware General Corporation Law in the wake of any “corporate trauma.” In addition, the South decision found that dismissal of the South complaint did not preclude other Hecla shareholders from filing future derivative suits because the South plaintiffs did not use Section 220 and, therefore, did not adequately represent Hecla’s interests.


High Frequency Traders and Algorithmic Strategies on German Trading Venues

Bradley Sabel is partner and co-head of the Financial Institutions Advisory & Financial Regulatory practice group at Shearman & Sterling LLP. This post is based on a Shearman & Sterling client publication by Dr. Andreas Wieland.

The German Government plans to curtail high frequency trading on German trading venues and to submit certain algorithmic trading strategies to regulatory supervision. In its cabinet meeting on September 26, 2012 the Federal Government adopted a revised draft legislation titled the “Act for the Prevention of Risks and the Abuse of High Frequency Trading” (Hochfrequenzhandelsgesetz). [1] This post provides a short overview on the adopted draft legislation and explains the main differences to the earlier discussion draft described in our client publication in August 2012. [2]


Today, algorithmic high frequency trading accounts for approximately 50% of the trading volume at German trading venues. Currently, Germany has no specific rules applying to high frequency and other algorithmic traders and trading strategies. Since extreme and irrational price fluctuations like the US flash crash on May 6, 2010 have occurred, there is an increasing concern about the impact of computer based algorithmic high frequency trading (“HFT”) and its impact on market integrity and efficiency. These worries appear to be supported by subsequent events like the Knight Capital trading glitch and various other events blamed on HFT.


Evaluating Large-Scale Asset Purchases

Editor’s Note: This post is based on the recent remarks of Jeremy C. Stein, a member of the Board of Governors of the Federal Reserve System, at the Brookings Institution; the full speech, including footnotes, is available here.

I’d like to describe the framework I have been using to think about monetary policy in the current environment, focusing primarily on the role of large-scale asset purchases (LSAPs).

There is a considerable diversity of views within the FOMC, and among economists more generally, about the use of LSAPs and other nonconventional policy tools. This diversity is both inevitable and healthy given the unprecedented circumstances in which we find ourselves. To be clear on where I stand, I support the Committee’s decision of last month—namely, to initiate purchases of mortgage-backed securities (MBS) at a rate of $40 billion per month, in tandem with the ongoing maturity extension program (MEP) in Treasury securities, and to plan to continue with asset purchases if the Committee does not observe a substantial improvement in the outlook for the labor market. Given where we are, and what we know, I firmly believe that this decision was the right one.

In my comments, I will only briefly review the case for taking action, as that ground has been well covered in a number of other places, most notably in Chairman Bernanke’s recent Jackson Hole speech. Instead, I will explore in more detail the factors that make decisions about LSAPs so challenging. The Chairman discussed these challenges in his recent speech, saying: “Estimates of the effects of nontraditional policies on economic activity and inflation are uncertain, and the use of nontraditional policies involves costs beyond those generally associated with more-standard policies. Consequently, the bar for the use of nontraditional policies is higher than for traditional policies.”


The Shareholder Base and Payout Policy

The following post comes to us from Andriy Bodnaruk of the Finance Department at the University of Notre Dame and Per Östberg of the Swiss Finance Institute.

In our paper, The Shareholder Base and Payout Policy, forthcoming in the Journal of Financial and Quantitative Analysis, we examine the relation between the shareholder base and payout policy. Finance practitioners acknowledge that having a broad shareholder base is an important factor for many corporate decisions. For example, in a recent study of firm payout policy, Brav, Graham, Harvey, and Michaely (2005) survey financial executives and conclude that “With respect to payout policy, the rules of the game include … [to] have a broad and diverse investor base…” Despite the apparent importance of the shareholder base there is little academic evidence relating shareholder base to corporate decisions. In this paper we investigate the effect of the shareholder base on the level and method of payout.

Shareholder base and payout policy of the firm are linked through a firm’s cost of capital. There are at least two reasons to expect that companies with a smaller shareholder base would have a higher cost of capital and, hence, be less flexible in their choice and size of payout. First, having a large shareholder base may reduce asymmetric information between insiders and outsiders through more information production. Second, the shareholder base may be related to the recognition of the firm and hence the availability of external financing. For example, Merton (1987) states that “an increase in the relative size of the firm’s investor base will reduce the firm’s cost of capital and increase the market value of the firm.”


Politicized Proxy Advisers vs. Individual Investors

Editor’s Note: James R. Copland is the director of the Manhattan Institute’s Center for Legal Policy. This post is based on an article by Mr. Copland that first appeared in the Wall Street Journal.

In the boardrooms of America’s largest corporations, a company with scarcely over $100 million in annual revenue and $10 million in profits commands directors’ full attention: the proxy advisory firm Institutional Shareholder Services. ISS advises pension funds, mutual funds and hedge funds on how to vote on corporate ballot items.

The company is the dominant proxy adviser, reporting 1,700 clients that manage an estimated $26 trillion in assets. But its role in corporate governance is largely a creation of federal regulations—and its positions on countless ballot items follow the lead of special-interest investors like labor-union pension funds and “socially responsible” investing vehicles, not those of the average diversified investor.

In 2011 and 2012, for example, every public company in the Fortune 200 held an advisory vote on executive pay as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act. According to an analysis by the Manhattan Institute, ISS recommended that shareholders vote against 44 compensation packages in 338 “say on pay” votes (13%), but a majority of shareholders opposed executive pay at only six companies (1.5%).


Dodd-Frank Whistleblower Provision and Court’s Broad Interpretation

The following post comes to us from John S. Kiernan, partner and co-chair of the litigation department at Debevoise & Plimpton LLP, and is based on a Debevoise & Plimpton client update by Jonathan R. Tuttle, Colby A. Smith, Ada Fernandez Johnson, Michael A. Janson, Jyotin Hamid and Mary Beth Hogan.

On September 25, 2012, a federal judge in Connecticut resolved an apparent tension between the anti-retaliation provision of the Dodd-Frank Act (“Dodd-Frank” or the “Act”) and the definition of “whistleblower” under that Act in a way that broadly interprets the protections afforded to employees who report issues they “reasonably believe” constitute violations of the securities laws, even where the employee has never raised the issue with the Securities and Exchange Commission (“SEC”). The decision by Judge Stefan R. Underhill in Kramer v. Trans-Lux Corp., No. 3:11-cv-01424, 2012 WL 4444820 (D. Conn. Sept. 25, 2012), appears to be the first in which a judge has allowed a whistleblower anti-retaliation claim under Dodd-Frank to proceed past the motion to dismiss stage. [1]

Under Judge Underhill’s ruling, whistleblower protection extends to all individuals who report or disclose, either internally or to the SEC, alleged violations that are “required or protected” under the Sarbanes-Oxley Act of 2002, the Securities Exchange Act of 1934, 18 U.S.C. § 1513(e), or any other law, rule, or regulation subject to the jurisdiction of the SEC. The Kramer ruling could embolden corporate employees to claim whistleblower protection for a broad range of activities.


The Future of Bailouts and Dodd-Frank

Editor’s Note: Peter J. Wallison is a senior fellow at the American Enterprise Institute. This post is based on an article by Mr. Wallison; the full article, including footnotes, is available here.

In the first presidential debate, Mitt Romney identified the Dodd-Frank Act as the “biggest kiss” to Wall Street, opening a topic that has received too little attention in this election season. Supporters of the act argue that it ends bailouts, but this is true only if bailouts are defined narrowly as the use of taxpayer funds to rescue a failing financial institution. However, the source of funds for a bailout is not the real issue. The possibility of a creditor bailout creates moral hazard, no matter where the bailout funds originate, and it is moral hazard that provides the largest banks or other large financial firms with competitive advantages. The same is true of the special “stringent” regulation required by the act for banks and other firms deemed systemically important. These provisions create moral hazard by reassuring creditors that there is less risk in lending to these large firms than to small ones, and thus provide the biggest firms with a continuing competitive advantage in the form of lower funding costs. Romney is correct to see this as a subsidy to big banks and other large financial institutions. Title I invokes stringent regulation for systemically important firms, Title II provides a mechanism for bailing out creditors if a systemically important firm should fail, and Title VIII authorizes Federal Reserve funding for an unlimited number of additional financial institutions. If President Obama is re-elected, Dodd-Frank is likely to continue in its current form, adding materially to the problem of moral hazard and TBTF in the US financial system.

At its enactment, the Dodd-Frank Act (DFA) was advertised as legislation that would end financial bailouts. When signing the legislation on July 21, 2010, President Obama said, “There will be no more tax-funded bailouts—period.” But this is an accurate depiction of the act only because the president and the act’s other proponents define bailouts as the use of public funds for rescuing failing financial institutions.


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