Monthly Archives: October 2012

Lessons from the Wet Seal Consent Solicitation

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Wednesday, October 17, 2012
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Editor’s Note: Greg Taxin is managing director of Clinton Group, Inc.

On Friday, October 5, 2012, the Wet Seal (Nasdaq: WTSLA) made an unusual announcement: a majority of its board had agreed to step down and be replaced by nominees selected by a shareholder. It did so even though its board had been duly elected less than five months prior, on May 16, at the company’s annual meeting.

The board, however, recognized that it was within minutes of being defeated in a consent solicitation fight that our fund had started in September. In less than one month — outside of the usual annual and special meeting process — shareholders had successfully replaced (and, in our view, upgraded) a majority of the board.

This was a resounding victory for shareholders and an unusual exercise of their rights. Shareholders owning as much as 63% of the stock consented to the proposals, which involved removal of four of the five sitting directors and the election of four new directors in their stead. Among the consenting investors were mutual funds, institutional investors, large individual investors, former executives and hedge funds. The stock was held widely and dozens of professional investors consented to the proposals. At least one very large mutual fund was on the verge of adding their consent to the pile (which would have brought the totals into the high 60s) when we elected to deliver the consents to the company.

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Good Walls, Better Compliance: OCIE’s Report

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, October 17, 2012
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The following post comes to us from Anna T. Pinedo, partner focusing on securities and derivatives at Morrison & Foerster LLP, and is based on a Morrison & Foerster memorandum.

On September 27, 2012, the Staff of the SEC’s Office of Compliance Inspections and Examinations published a summary of examinations conducted by the SEC, the NYSE and FINRA of information barriers and practices of nineteen broker-dealers, including six of the largest broker-dealers. FINRA’s examinations included a review of the practices of smaller broker-dealers that focus on PIPE transactions. The review focused on the information walls and other systems in place to ensure compliance with regulatory requirements related to the handling of material nonpublic information, or MNPI. Mishandling of MNPI may result not only in exposure to regulatory charges, but also to civil liability and reputational damage. While the report does not constitute an order or finding by the SEC, it provides valuable insight into the Staff’s views, which will likely be reflected in future examination reports (and possibly enforcement actions) by the SEC, FINRA and the NYSE.

The report cites a number of specific concerns, including: informal and undocumented interaction between groups having MNPI and internal and external groups that have sales and trading responsibilities; senior executives designated as “above-the-wall” receiving MNPI without being subject to any monitoring or restrictions despite their managerial responsibilities for business units involved in sales and trading; the lack of a review process to evaluate trading that occurred after MNPI was provided to sales, trading or research personnel for business purposes; and gaps in oversight coverage.

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Bank Recovery and Resolution: What About Shareholder Rights?

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, October 17, 2012
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The following post comes to us from Valia Babis at University of Cambridge.

In the post-financial crisis regulatory reforms, emphasis has been placed on creating recovery and resolution frameworks for banks, which ensure that the costs of failure are born by private parties (primarily shareholders), instead of taxpayers and the wider economy. Supervisors have (or will have) extensive powers on banks, e.g. to remove and replace directors, to appoint “special managers”, to transfer shares and assets of banks to third parties, and even to cancel existing shares and issue new shares in order to “replace” existing shareholders. The purpose of this article, Bank Recovery and Resolution: What About Shareholder Rights?, is to examine the potential impact of bank recovery and [1] and of the United Kingdom (the special resolution regime for banks established by the Banking Act of 2009).

The article begins by studying the rationale for shareholder protection, especially in the banking sector. It subsequently studies the main shareholder rights, which include: property rights, governance rights (including pre-emption rights, appointment of directors and involvement in management), procedural rights, protection of minority shareholders, and protection of shareholders in banking groups (through the principles of separate legal personality and limited liability).

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Equity Decoupling and Empty Voting: The TELUS Zero-Premium Share Swap

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, October 16, 2012
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The following post comes to us from Bernard Black, the Nicholas D. Chabraja Professor at Northwestern University School of Law and Kellogg School of Management and Professor of Finance at Kellogg School of Management.

In a series of articles, Henry Hu and I developed and defined the concept of empty voting. TELUS Corp. has separate classes of voting and nonvoting shares. It proposes to combine them, with a zero premium for voting shares. Mason Capital has taken a (long voting shares, short nonvoting shares) position, is thus long the value of TELUS voting rights, and is campaigning for a share-swap plan which assigns a reasonable value to those rights. TELUS has claimed that Mason is engaging in “empty voting”, and has persuaded a British Columbia court of this (TELUS is incorporated in BC).

I discuss here some aspects of this dispute. For a vote which involves the value of voting rights: (i) Mason has an economic interest in this outcome, and thus is not an empty voter; (ii) many other TELUS shareholders are empty voters, because they have negative or near-zero economic interest in TELUS votes; (iii) TELUS management is conflicted, because they hold mostly nonvoting shares; (iv) voting rights are valuable, and the market premium accorded to TELUS voting shares is a reasonable estimate of their value; in contrast, zero is not a reasonable value; (v) by valuing voting rights at zero, the TELUS board is likely violating its fiduciary duty to treat both share classes fairly; and (vi) if the TELUS voting shareholders reject the zero-premium share-swap, it would likely be a further breach of fiduciary duty for TELUS not to propose a swap on terms which assign a reasonable value to votes.

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Regulatory Capital Estimation Tool: Observations

Posted by Dwight C. Smith, Morrison & Foerster LLP, on
Tuesday, October 16, 2012
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Dwight C. Smith is a partner at Morrison & Foerster LLP focusing on bank regulatory matters. This post is based on a Morrison & Foerster client alert by Mr. Smith.

On September 24, 2012, the federal banking agencies released the “Regulatory Capital Estimation Tool,” intended to help community banking and thrift organizations estimate the overall impact on their capital levels of the proposed revisions to the U.S. regulatory capital rules that were published this past summer. [1]

The tool will serve at least two purposes. The resulting estimates should provide a new source of quantitative information for a bank’s capital planning. They should also spur an assessment of the impact of the proposed rules and how the bank might provide a meaningful comment on the proposed rules. The comment period expires three weeks from today, on October 22, 2012. [2] The tool involves two of the three regulatory capital rules that the agencies proposed in June 2012: the Basel III Proposal, which addresses capital components and capital ratios, and the Standardized Approach Proposal, which sets forth risk weights for different asset classes. [3]

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Materiality and the Fraud-on-the-Market Presumption

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, October 16, 2012
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The following post comes to us from Paul A. Ferrillo, litigation counsel at Weil, Gotshal & Manges LLP. This post is based on an article by Mr. Ferrillo, Robert F. Carangelo, David Schwartz and Matt Altemeier that first appeared in Law 360.

In November 2012, the United States Supreme Court will again hear an appeal of a federal securities class action in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds (No. 11-1085) (“Amgen”). In the past two years, the Supreme Court has heard no less than five appeals arising from securities class actions.

Amgen requires the Court to reconsider its own landmark decision in Basic Inc. v. Levinson, 485 U.S. 224 (1988), adopting a rebuttable classwide presumption of reliance based on the “fraud-on-the-market” (“FOTM”) theory. The FOTM theory assumes that the market price of securities traded in an efficient market reflects all publicly-available information, including any material misrepresentations. Twenty-five years later, the parties in Amgen ask the Court to resolve whether, in such a case, a district court must (1) “require proof of materiality” concerning the challenged statements and/or (2) “allow the defendant to present evidence rebutting the applicability of the fraud-on-the-market theory” before certifying a class under Fed. R. Civ. P. 23(b)(3). To fully understand the import of these questions, some background on the relevant concepts is helpful.

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Securities Offerings During Blackout Periods and Following a Quarter-End

Posted by Richard J. Sandler, Davis Polk & Wardwell LLP, on
Monday, October 15, 2012
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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.

Many companies voluntarily impose a “blackout period” beginning around the time a quarter ends and continuing through the quarter’s earnings announcement or subsequent 10-Q or 10-K filing. Although the company’s directors and officers are therefore barred by company policy from trading during this period, it may nevertheless be possible for the company or its major stockholders to complete a securities offering on a public or private basis. The existence of a company-imposed blackout period does not, as a legal matter, prevent the company or a major stockholder from selling securities as long as the company is able to meet its duty of disclosure.

This post discusses what factors company management and their underwriters should consider when contemplating a securities offering during a blackout period. We focus particularly on US companies that are already subject to SEC reporting requirements and that are up-to-date with their filings — IPO companies, companies not subject to SEC reporting and companies that are behind in their SEC filings will have additional matters to consider.

A note of caution is appropriate — this post offers a blinking-yellow light, not a green light. In many cases the best course of action will be to schedule the offering after the 10-Q or 10-K is filed. Nevertheless, in a period of rapidly shifting investor receptivity to new issues, a company and its underwriters may decide that the balance of considerations favors moving more quickly to market.

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The Political Economy of Insider Trading Law and Enforcement

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, October 15, 2012
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The following post comes to us from Laura N. Beny, Professor of Law at the University of Michigan Law School.

Across the globe, many view insider trading as a threat to stock market integrity and efficiency. This is evidenced by the fact that, as of 2000, eighty-seven countries had enacted insider trading legislation and thirty-eight had prosecuted insider trading at least once. However, these laws vary in stringency and many of them were enacted only recently. Enforcement intensity also varies across countries, with some countries regularly enforcing insider trading laws and others allowing insiders to trade with impunity notwithstanding the laws on the books. The aim of this study, The Political Economy of Insider Trading Law and Enforcement: Law vs. Politics? International Evidence, is to provide a greater understanding of the political and economic determinants of the differential timing of insider trading legislation and enforcement across countries.

Those who oppose insider trading regulation often rely on the private interest theory of regulation to explain how these laws, despite their presumed inefficiency, are enacted to satisfy influential private interests. In contrast, those who support insider trading restrictions rely on the public interest theory of regulation to explain how insider trading regulation is enacted to address market failures. The two theories are rarely merged into a single framework. However, because insider trading and its regulation concern the distribution of property rights to use private corporate information, the issue has both private (distributional) and public (efficiency) dimensions. I take both dimensions into account in this study.

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Rich-Hunt: The Speech

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Monday, October 15, 2012
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Editor’s Note: The following post comes to us from Roger Donway, program director of the Atlas Society’s Business Rights Center. This post is based on an edited version of Mr. Donway’s remarks at the Atlas Society’s 2012 summer conference, available here.

My monograph Rich-Hunt is subtitled “The Backdated Options Frenzy and the Ordeal of Greg Reyes.” But if you have not read the monograph, and if you missed the whole frenzy of 2005–2011, you may well wonder: What is a backdated option? Indeed, you may not even be quite sure about what an option is and how it works. So, let me start there.

An option is a type of security that gives a person the right to buy a share of a company’s stock at a specified price. For example, an option might give you the right to buy a share of Google at $5. That would be a very valuable option. Or an option might give you the right to buy a share of Google at $5,000. That would not be so valuable.

Typically, when a company gives options to its employees as a form of compensation, the employees are allowed to buy shares in the company (which is called “exercising the options”), and the price at which they may buy the stock is called the option’s “exercise price,” or “strike price.” Typically, however, they can exercise their options only after a defined span of time (called “the vesting period”) and before a certain date (called “the expiration date”).

So, the value of such option grants rests entirely on the possibility that the stock will be selling above the strike price during the period of time that the employee is permitted to use the option to buy a share. If the stock price is higher than the exercise price, the employee can reap a profit by purchasing a share of stock at the exercise price and then immediately selling that share on the stock market. Of course, if the stock price does not rise above the strike price between the time that the options vest and the time that they expire, then the options are forever worthless.

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How Global Benchmark Rates Failed and Can Recover

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Sunday, October 14, 2012
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Editor’s Note: Gary Gensler is chairman of the Commodity Futures Trading Commission. This post is based on Chairman Gensler’s remarks before the European Parliament, Economic and Monetary Affairs Committee, available here.

In June, the financial markets were taken aback when the Barclays settlement was announced.

What were the systemic failures, how widespread is the problem, what action is being taken and what future reforms are necessary?

I will try to answer these questions.

How did it happen?

LIBOR is supposed to be the average rate at which the largest banks honestly believe they can borrow from one another unsecured, or without posting collateral. LIBOR was set up in the 1980s when banks regularly made loans to other banks on that basis.

There are at least three issues with LIBOR and other survey rates, such as Euribor, that I would like to discuss with you. The first and possibly the most significant issue with LIBOR is that the number of banks willing to lend to one another on an unsecured basis has been sharply reduced over the years.

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