Monthly Archives: October 2012

A Corporate End-User’s Handbook for Dodd-Frank Title VII Compliance

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Saturday, October 13, 2012
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The following post comes to us from Geoffrey B. Goldman, partner focusing on derivatives and structured products at Shearman & Sterling LLP. This post is an abridged version of a Shearman & Sterling publication, titled A Corporate End-User’s Handbook for Dodd-Frank Title VII Compliance, available in full (including footnotes) here.

I. Introduction

Almost four years after the financial crisis and over two years after the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), the overhaul of the US derivatives market is rapidly shifting into the implementation phase. Many of the key elements of Dodd-Frank relating to OTC derivatives will begin to take effect on October 12, 2012, although the CFTC has delayed implementation of some requirements until the beginning of 2013.

Under Dodd-Frank, Swap Dealers, Security-Based Swap Dealers, Major Swap Participants (“MSPs”) and Major Security-Based Swap Participants must register with the CFTC or SEC, as appropriate, and thereafter will be subject to strict regulation. Swap Dealers and MSPs will be required to comply with, among other things, regulations governing minimum margin and capital requirements, mandatory clearing and exchange trading of swaps and security-based swaps, swap reporting and recordkeeping requirements, internal and external business conduct standards and position limits. Even for companies that are not Swap Dealers or MSPs, are predominantly engaged in non-financial activity, and are using swaps or security-based swaps to hedge or mitigate commercial risk (“End-Users”), compliance with Dodd-Frank presents a significant challenge.

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The Wheatley Review of LIBOR: Final Report

Posted by David Felsenthal, Clifford Chance LLP, on
Friday, October 12, 2012
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David Felsenthal is a partner at Clifford Chance LLP focusing on financial transactions. This post is based on a Clifford Chance client memorandum. For further analysis of the final report, see PricewaterhouseCoopers’s memo that was sent to us by Vincent O’Sullivan, available here.

The final report of the Wheatley Review on LIBOR has been published. The report concludes that LIBOR should be retained as a benchmark, but, as expected, recommends a comprehensive reform of LIBOR, which includes replacing the British Bankers Association (BBA) with a new independent administrator of LIBOR. Given the different contexts (as well as the number and types of transactions) in which LIBOR is used, the report raises various questions which should be considered by market participants as to the implications of the recommendations for existing and future transactions.

This briefing outlines the ten-point plan for reform set out in the report. It concludes by setting out some of the matters which should be considered by market participants involved in LIBOR linked transactions.

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Gender Diversity on Public Company Boards

Posted by David A. Katz, Wachtell, Lipton, Rosen & Katz, on
Friday, October 12, 2012
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David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz specializing in the areas of mergers and acquisitions and complex securities transactions. This post is based on an article by Mr. Katz and Laura A. McIntosh that first appeared in the New York Law Journal; the full article, including footnotes, is available here.

The issue of gender diversity in the corporate boardroom has risen to new prominence in the wake of recent efforts to impose quotas for women directors for companies in the European Union. The EU’s recent initiative has provoked controversy not only as to the optimal gender balance of boardrooms but also as to whether a quota system is a fair or effective way to achieve the underlying objective of women’s full and equal participation in corporate affairs. In the United States, the relative dearth of women directors on public company boards, and the potential effect on company performance of increased gender diversity, has been a topic of interest in the corporate governance sphere for many years.

The meaningful participation of women at all levels of the corporate hierarchy is an important goal. From a practical perspective, however, we believe that aspects of the European experience demonstrate the downsides of using a quota system to obligate this result. Individual public companies, and the U.S. corporate culture generally, would, in our view, be best served by corporate boards’ taking a dedicated, thoughtful and individualized approach to the nomination, election and full integration of women directors. This approach seems likely to yield the most successful substantive result in the short and long term, producing benefits both for corporate performance and the common weal.

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Rational Boundaries for Cost-Benefit Analysis in SEC Rulemaking

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, October 12, 2012
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The following post comes to us from Bruce Kraus, a partner at Kelley Drye & Warren LLP and former co-Chief Counsel of the SEC’s Division of Risk, Strategy, and Financial Innovation.

In a recent paper co-authored with Connor Raso, I argued that D.C. Circuit’s Business Roundtable decision has set a very high bar for cost-benefit analysis in rulemaking by financial regulators like the SEC. In 2011, the court struck down the agency’s long-pondered proxy access rule—a rule expressly authorized by Dodd-Frank—and did so in a way that calls into question the practical ability of the SEC and other financial regulatory agencies with similar mandates to adopt future rules that will withstand timely challenge.

Our paper, Rational Boundaries for Cost-Benefit Analysis in SEC Rulemaking (forthcoming, Yale Journal on Regulation), analyzes the interplay of legislative, executive, agency and judicial actions over the last thirty years that led to this situation. We point out the contradiction between the Commission’s structure (bipartisan by statute and often requiring logrolling compromises to reach a result) and the assumption of global rationality that underlies cost-benefit analysis.

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Court Vacates Position Limit Rules

Posted by James Morphy, Sullivan & Cromwell LLP, on
Thursday, October 11, 2012
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James Morphy is a partner at Sullivan & Cromwell LLP specializing in mergers & acquisitions and corporate governance. This post is based on a Sullivan & Cromwell publication.

Summary

On October 18, 2011, the Commodity Futures Trading Commission (“CFTC”) adopted interim and final rules on positions limits applicable to options, futures contracts and swaps (including swaptions) related to 28 agricultural, metal and energy commodity contracts under Part 151 of its regulations (the “Position Limit Rules”) as well as amended existing position limits applicable to options and futures contracts under Part 150 of its regulations. [1] The Position Limit Rules would have expanded the existing position limits regime to, among other things, apply to swaps, limit available hedging exemptions and impose stricter aggregation requirements. On December 2, 2011, the International Swaps and Derivatives Association (“ISDA”) and the Securities Industry and Financial Markets Association (“SIFMA”) filed a challenge to the Position Limit Rules in the U.S. District Court for the District of Columbia (the “Court”). Initial position limits under the Position Limit Rules were due to take effect on October 12, 2012. On September 28, 2012, the Court vacated the Position Limit Rules, remanding them to the CFTC.

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Changes to CFTC Regulations Affecting Private Funds

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, October 11, 2012
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The following post comes to us from Douglas P. Warner, senior member of the Private Equity practice and head of the Hedge Fund practice at Weil, Gotshal & Manges LLP. This post is based on a Weil Gotshal client alert by Richard Ellenbogen and Venera Ziegler.

Who Is Affected?

As a result of recent changes made to the Commodity Exchange Act by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) and new Commodity Futures Trading Commission (the CFTC) rules, private fund sponsors investing in commodity interests need to examine their portfolios and determine whether they are subject to registration with the National Futures Association (NFA) or, if available, claim an exemption from such registration.

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Industry Expertise on Corporate Boards

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, October 11, 2012
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The following post comes to us from Olubunmi Faleye of the Finance Department at Northeastern University, Rani Hoitash of the Department of Accountancy at Bentley University, and Udi Hoitash of the Accounting Department at Northeastern University.

In our paper, Industry Expertise on Corporate Boards, which was recently made publicly available on SSRN, we propose and study a measure of board industry expertise. The question of who should sit on corporate boards has attracted significant academic and regulatory efforts in recent years. For example, on December 16, 2009, the U.S. Securities and Exchange Commission (SEC) released final proxy disclosure enhancement rules. Among other directives, these rules require registrants to “disclose for each director and any nominee for director the particular experience, qualifications, attributes or skills that qualified that person to serve as a director.”  A prominent feature of these disclosures has been an emphasis on related industry experience. In its first proxy filing under these rules, Hewlett-Packard stated that director Marc L. Andreessen “is a recognized industry expert and visionary in the IT industry” who has “extensive leadership, consumer industry and technical expertise” through his positions at and service on the boards of public and private technology companies.  Other major firms making similar claims include Coca-Cola Co., Wal-Mart Stores, and Bank of America.

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Investor Protection through Audit Oversight

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Wednesday, October 10, 2012
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Editor’s Note: The following post comes to us from Lewis H. Ferguson, board member of the Public Company Accounting Oversight Board. This post is based on Mr. Ferguson’s remarks at an SEC Financial Reporting Conference. The views expressed in this post are those of Mr. Ferguson and should not be attributed to the PCAOB as a whole or any other members or staff.

Anyone involved in the financial reporting process deals daily with the hard realities of complexity and rapid change — whether you are a preparer of financial statements, a board or audit committee member, an investor, an independent or internal auditor, a counselor, or a regulator.

Commercial activity is increasingly global. Some financial instruments and transactions are bafflingly complex with values that can only be estimated. Standard setters in the United States and abroad are moving away from historical cost accounting toward fair value accounting, requiring difficult estimates. There is a plethora of new rules and requirements growing out of the Dodd-Frank and JOBS acts in the United States, and all of this is happening in what since 2008 has been the most difficult global economic environment since the Great Depression of the 1930s.

Much as we struggle with these rapid changes and their complexity, regulators also struggle to see around the curve, to be prepared for what is coming tomorrow, and to have tools in their toolbox that will be appropriate for those challenges. In the next session of today’s conference, I will discuss a number of specific initiatives the PCAOB is undertaking to deal with some of these challenges, but in this address I want to focus on one specific area, the challenge of globalization and cross-border financial reporting, auditing and audit oversight.

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Inside Debt, Bank Default Risk, and Performance during the Crisis

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, October 10, 2012
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The following post comes to us from Rosalind L. Bennett and Levent Güntay, both of the Federal Deposit Insurance Corporation, and Haluk Ünal, Professor of Finance at the University of Maryland.

The role of executive compensation as a possible cause of the recent financial crisis has attracted significant attention from the public, policy makers, and researchers. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd Frank Act), which was signed into law on July 21, 2010, requires the regulatory agencies to prohibit the incentive-based compensation practices that encourage inappropriate risk-taking activities at financial institutions.

One question that emerged from this attention and the subsequent legislative action is whether there is a relation between executive compensation and excessive risk taking at banks. An extensive body of research examines the relation between risk taking and the inside equity (stock options and firm equity) holdings of the chief executive officer (CEO). In our paper “Inside Debt, Bank Default Risk and Performance during the Crisis,” which was recently made publicly available on SSRN, rather than focus on inside equity, we instead study inside debt (pension benefits and deferred compensation). In particular, we investigate whether the bank holding companies (BHCs) that compensate their CEOs with higher inside debt relative to inside equity, the inside debt ratio, had a lower risk of default and better performance during the most recent financial crisis. Furthermore, we explore whether the inside debt ratio has more power to explain the default risk and the performance in BHCs than the measures based on inside equity.

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Pan-European Short Selling Regulation

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, October 9, 2012
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The following post comes to us from Stephen P. Wink, partner in the Corporate Department at Latham & Watkins LLP. This post is based on a Latham & Watkins client alert by Mr. Wink, Vladimir Maly and Gitanjali P. Faleiro; the full document, including complete footnotes, is available here.

I. Introduction and Overview

As previously described in our memorandum on the pan-European short selling regulation [1], the European Commission (the Commission) adopted a proposal on September 15, 2010 to harmonize the regulation of short sales and credit default swaps across the European Union. [2] On March 14, 2012, the European Parliament and the Council of the European Union (the Council) each voted to adopt the proposed regulation, after including a number of significant amendments (the Regulation). [3]

The Regulation has been in force since March 25, 2012 (a day after it was published in the Official Journal) and is due to become ‘directly’ effective in the EU Member States (each a Member State) on November 1, 2012. [4] As such, the Regulation will become law in each Member State in its own right without the need for domestic implementing measures. On September 13, 2012 the European Securities and Markets Authority (ESMA) published its first edition of Q&A on the ‘Implementation of the Regulation on short selling and certain aspects of credit default swaps,’ in response to frequently asked questions posed by market participants, market regulators and the general public. [5] On September 17, 2012, ESMA published its consultation paper on the Regulation’s exemption for market making activities and primary market operations.

The Regulation brings to an end the current fragmented approach to shortsale restrictions across Member States and also establishes a ‘preventive regulatory framework’ to be used in ‘exceptional circumstances’ for ‘temporary’ periods.

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