Monthly Archives: December 2012

Not All Money Market Funds Are Equal

Editor’s Note: Robert Pozen is a senior lecturer at Harvard Business School and a senior fellow at the Brookings Institution. This post is based on an article by Mr. Pozen and Theresa Hamacher that originally appeared in the Financial Times.

There is a sensible compromise to the debate over money market fund reform that regulators should seriously consider: requiring a fluctuating share price for some money market funds owned by institutional investors, but not for those owned by retail investors. Currently, all money market funds may use a fixed share price – known as the “net asset value”, or NAV – at one dollar per share, subject to strict conditions.

Regulators have argued that a fixed NAV creates systemic risk in the financial system and misleads investors into thinking their investment is guaranteed. They believe that money market funds should instead calculate their NAV daily based on the market value of their investments, as stock and bond mutual funds do – meaning that the NAV may fluctuate from day to day. However, the fund industry argues that a fluctuating NAV would drastically undermine the utility of money market funds. Most investors use money market funds as an alternative to bank deposits, so most investors require the convenience and liquidity of a fixed-dollar account. Additionally, the industry points out that only two money market funds – both institutional – have ever caused any investor losses by “breaking the buck”.


Enhancing the Relevance, Credibility and Transparency of Audits

Editor’s Note: James R. Doty is chairman of the Public Company Accounting Oversight Board. This post is based on Chairman Doty’s remarks before the AICPA National Conference on Current SEC and PCAOB Developments, available here. The views expressed in the post are those of Chairman Doty and should not be attributed to the PCAOB as a whole or any other members or staff.

I. High Quality, Independent Auditing is Critical to Our Economic Success.

As I have learned in this job, getting the accounting right is indeed not the same thing as getting the auditing right. My sense from accountants I talk to is that auditing is receiving well-deserved attention in its own right.

Our economic success depends on the confidence of the users of capital and the providers of capital alike. Corporate managers hire internal accountants — many of you here today — to ensure they have accurate and detailed information on which to base management decisions. Managers ignore opportunities to glean trends and insights from this data at their peril.

Mistakes in this information can send a company into a business line or market that squanders resources. We now know that the true cost of financial misstatement is much greater than stock market fallout, concomitant lawsuits and insurance claims.


Board Oversight of Management’s Risk Appetite and Tolerance

Matteo Tonello is managing director of corporate leadership at the Conference Board. This post is based on an issue of the Conference Board’s Director Notes series by Tim Leech, managing director of global services at Risk Oversight Inc. This Director Note is based on an article written by Mr. Leech; the full publication, including footnotes, is available here.

In the aftermath of the financial crisis, companies and their boards have been grappling with new disclosure requirements related to board risk oversight in the United States, Canada, and Europe. Unfortunately, many organizations that have wanted to improve their risk management capabilities have attempted to implement a traditional form of what is generally known as enterprise risk management (“ERM”). Many companies that have tried the traditional ERM route have been disappointed with the results. Many of these ERM programs have focused on multiple workshops that ask participants to identify potentially negative events, assess their likelihood and consequence, log risks identified in “risk registers,” plot them on color-coded risk “heat maps” and report the top 10, 20 or 100 risks to the board. In most ERM programs, this exercise is repeated each year and the updated risk register results are reported to the board or a committee of the board. This approach to ERM has proven to be suboptimal at best, and has even proved “fatal” when companies completely missed entity-threatening risks. These poor results can be related to the fact that these initiatives miss the fundamental point of formalized risk management—increasing certainty that objectives, both strategic and value creating, as well as core foundation objectives like obeying laws and producing reliable financial statements, will be achieved with a tolerable level of risk to senior management and the board.


Cybersecurity Risks and the Board of Directors

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.

As boards of directors examine the risks that their companies face, corporate cybersecurity issues loom large. Forty-eight percent of directors (and 55 percent of general counsel) cited data security as their top concern in a recent study by Corporate Board Member/FTI Consulting. These numbers have roughly doubled since 2008, when only a quarter of directors and general counsel cited data security as a major concern. With revenues, intellectual property, business relationships and customer confidence potentially at stake, directors should consider whether their companies and management teams are adequately addressing the growing threat of cybersecurity in the new high-tech landscape.

Cybersecurity risk is a difficult and intimidating topic for corporate boards to consider. However, it is important to keep in mind that cybersecurity risk is only one of many areas of risk that are overseen by boards of directors and that, in most cases, the usual strategies and procedures for evaluating and managing risk can apply. Directors are not expected to be experts in this area and are entitled to rely upon management and outside experts for information and advice. Nonetheless, directors should request that management reports to the board on the steps the company is taking to mitigate cyber threats, and directors should consider whether the company is appropriately assessing its risks and devoting adequate resources to the issue. The business judgment rule remains the standard for evaluating decisions taken by a board in this area.


Capital Formation from the Investor’s Perspective

Editor’s Note: Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s remarks at the AICPA Conference on Current SEC and PCAOB Developments; the full speech, including footnotes, is available here. The views expressed in this post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

I would like to talk about capital formation and the critical role that accountants play in that process. I want to particularly focus on capital formation from the investor’s perspective. Too often, the investor perspective is lost in the discussion over capital formation. The companies, lawyers, and investment bankers that often dominate this discussion often see regulation only as an obstacle to be overcome. They focus the discussion on how to raise money quicker and more cheaply — but seem to forget that the money raised comes from the pockets of hard-working Americans. The capital raising process should not make investors more vulnerable, and attempts to raise money quicker and more cheaply should not come at the investor’s expense. I want to put the focus on investors and examine how protecting investors facilitates capital formation by enhancing confidence, promoting integrity, and fostering transparency.


Meaningful Corporate Political Disclosure

The following post comes to us from Bruce Freed, president and a founder of the Center for Political Accountability, and Sol Kwon, associate director at CPA. Work from the Program on Corporate Governance about corporate political spending includes Shining Light on Corporate Political Spending by Lucian Bebchuk and Robert Jackson, discussed on the Forum here. A committee of law professors co-chaired by Bebchuk and Jackson submitted a rulemaking petition to the SEC concerning corporate political spending; that petition is discussed here.

In the aftermath of the most expensive election cycle in U.S. history, which included record amounts of “Dark Money,” the need for transparency in corporate political spending is even more urgent. Chevron made headlines in October when it gave $2.5 million to the Congressional Leadership Fund, a super PAC led by Speaker John Boehner (R – Ohio). While contributions to super PACs are required to be reported to the Federal Election Commission, contributions to their companion organizations, the so-called “social welfare” groups organized under the 501(c)(4) section of the Internal Revenue Service, remain entirely hidden.

Tellingly, the number of companies recognizing the need for more transparency and actually making the voluntary spending disclosure has increased in recent years. That trend was documented in the 2012 CPA-Zicklin Index of Corporate Political Accountability and Disclosure, which ranked the top 200 companies in the S&P 500 on their policies and practices on political activities.


Calling Regulators to Account

The following post comes to us from Julia Black, Professor of Law at the Law Department of London School of Economics.

Since their inception, the accountability of independent regulatory agencies has been of concern to scholars of public law and political science. But whilst many decry the lack of accountability of regulatory agencies, others (albeit a minority) argue that accountability demands are counter-productive or subverted, prevent the agency from performing its role effectively or create cultures of blame.

The challenges of calling regulators to account are deep-rooted. The first key challenge is that of fluidity and ambiguity: the tension between independence, political control and political accountability creates an ambiguity in the responsibilities of the core executive and regulatory agencies which both, but particularly the executive, can seek to exploit. As a result, lines of responsibility and thus of accountability can be unclear, to say the least, particularly when things go wrong.


Charting a Path to Sustainability Leadership

Matteo Tonello is managing director of corporate leadership at the Conference Board. This post is based on an issue of the Conference Board’s Director Notes series by James Cerruti, senior partner of strategy and research at Brandlogic Corp. This Director Note is based on an article written by Mr. Cerruti; the full publication is available here.

Operational sustainability performance is becoming increasingly important to corporations and their stakeholders, but operational performance is not the only measure that matters. There is also considerable value in communicating the corporate sustainability story. This report looks at the potential benefits to corporations of demonstrating good environmental, social, and governance (ESG) performance and discusses five common characteristics of sustainability “leaders”—companies that excel in both the operational and communication dimensions of sustainability.

As economic and societal priorities change over time, so do the criteria that define corporate leadership. The world’s “best” organizations have, at various times, been identified as those that excel in research and development and new product development, those that display excellence in operational and process reengineering, or those best able to focus on core competencies. More recently, the yardstick has been the ill-defined term “innovation”—the ability to be a game changer via breakthrough products or business models.


Fed Governor Tarullo Foreshadows Foreign Banks Proposal

Margaret E. Tahyar is a partner in Davis Polk & Wardwell LLP’s Financial Institutions Group. This post is based on a Davis Polk publication; key features of Governor Tarullo’s proposal are illustrated in a Davis Polk graphic, available here.

In an unprecedented and provocative speech, Federal Reserve Governor Daniel K. Tarullo foreshadowed a proposal from the Federal Reserve Board that could fundamentally change the way foreign banks are regulated in the United States. As previewed, the proposal would require foreign banks with large operations in the U.S. to create a separately capitalized top-tier U.S. intermediate holding company (“IHC”) that would sit on top of all U.S. bank and nonbank subsidiaries. The IHC would be required independently to meet all U.S. capital and liquidity requirements as well as other enhanced prudential standards required by the Dodd-Frank Act. While the U.S. branches and agencies of a foreign bank would not be part of the IHC, they would be subject to “certain additional measures,” especially regarding liquidity. Governor Tarullo noted that the “all-important details” of the proposal are still under discussion and anticipated the release of a notice of proposed rulemaking “in the coming weeks.”

If the Federal Reserve actually adopts a proposal along the lines outlined in Governor Tarullo’s speech, it could have profound negative implications not only for the operations of foreign banks in the United States, but also for U.S. banking organizations doing business outside the United States. It would likely contribute and add fuel to the growing trend towards regionalization of global banking, thereby complicating and increasing the cost of providing cross-border banking services.


The Dynamics of Compensation Peer Benchmarking

The following post comes to us from Michael Faulkender of the Robert H. Smith School of Business at the University of Maryland and Jun Yang of the Kelley School of Business at Indiana University.

Changes in the level and dispersion of CEO compensation since the early 1990s have triggered an increasingly heated debate over whether current compensation practices primarily reflect the equilibrium outcome of the CEO labor market or the power of entrenched CEOs. One factor in this debate is the practice of compensation benchmarking in which firms justify their CEO’s compensation by comparing it to the pay packages of a group of companies with highly paid CEOs. Firms rationalize this group by claiming they compete for managerial talent with those selected peer companies. In the paper, Is Disclosure an Effective Cleansing Mechanism? The Dynamics of Compensation Peer Benchmarking, forthcoming in the Review of Financial Studies, we examine the dynamics of the peer benchmarking process. Specifically, we investigate whether the 2006 regulation requiring firms to disclose their compensation peer group members has mitigated opportunistic firm behavior in benchmarking against self-selected peer companies with highly paid CEOs.


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