Yearly Archives: 2012

Differences Between US and UK Market Abuse Regimes

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Saturday, April 7, 2012
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The following post comes to us from John H. Sturc, co-chair of the Securities Enforcement Practice Group at Gibson, Dunn & Crutcher LLP, and is based on a Gibson Dunn alert by Mr. Sturc, Jeffery Roberts, Selina Sagayam, James Barabas, and Edward Tran.

The UK Financial Services Authority (“FSA”) imposed fines of £3.651 million ($5.77 million) on Greenlight Capital Inc., a US hedge fund manager (“Greenlight”), £3.638 million ($5.74 million) on David Einhorn, Greenlight’s owner, and £350,000 ($553,000) on Andrew Osborne, a former Bank of America Merrill Lynch banker. These fines were levied in connection with Greenlight’s trading in the shares of Punch Taverns Plc (“Punch”), a UK pubs business, ahead of a planned equity offering. The FSA imposed the fines on the grounds that Greenlight traded on inside information conveyed to David Einhorn during a conference call with Punch’s CEO and Andrew Osborne, its broker. Greenlight specifically declined to be made an insider for the purposes of the call and David Einhorn requested that he would not be “wall crossed.” Notwithstanding this, the FSA determined that the information conveyed amounted to inside information, that trading on this information was prohibited by the UK’s market abuse regime and that Greenlight, David Einhorn and Andrew Osborne should have been aware of this. It is unlikely that Greenlight’s trading would have triggered an enforcement action by the US Securities and Exchange Commission (“SEC”) if it had occurred in the context of a US exchange. However, US financial institutions and other market participants active in UK financial markets should take note of the FSA’s actions as this case illustrates key differences between the regulation of insider trading and market abuse in the US and the UK, and the FSA’s more aggressive policing of UK markets.

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The JOBS Act and General Solicitation

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, April 6, 2012
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The following post comes to us from Latham & Watkins LLP, and was coauthored by Latham and thirteen other firms, who are listed at the end of the memorandum. The memo is available here.

President Obama signed into law this week the Jumpstart Our Business Startups Act (JOBS Act). Title II of the JOBS Act affects offerings by issuers pursuant to Regulation D under the Securities Act, as well as resales under Securities Act Rule 144A. In particular:

  • Section 201(a)(1) of the JOBS Act directs the Securities and Exchange Commission (SEC) to amend Rule 506 to make the prohibition against general solicitation or general advertising contained in Rule 502(c) inapplicable to offers and sales under Rule 506, provided that all purchasers are accredited investors.
  • Section 201(a)(2) requires the SEC to revise Rule 144A to provide that securities sold under Rule 144A may be offered to persons other than qualified institutional buyers (QIBs), including by means of general solicitation or general advertising, provided that securities are only sold to persons reasonably believed to be QIBs.
  • Section 201(b) amends Section 4 of the Securities Act to provide that offers and sales exempt under Rule 506 as revised by Section 201 “shall not be deemed public offerings under the Federal securities laws” as a result of general advertising or general solicitation.

Section 201(a) requires the SEC to amend both Rule 506 and Rule 144A not later than 90 days after enactment of the JOBS Act. The following questions and answers reflect the current understanding of the undersigned law firms regarding transactions taking place during the period prior to the date the SEC’s amendments of Rule 506 and Rule 144A implementing Section 201(a) take effect (the interim period).

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Are Overconfident CEOs Better Innovators?

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, April 6, 2012
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The following post comes to us from David Hirshleifer and Siew Hong Teoh, both of the Paul Merage School of Business at the University of California, Irvine, and Angie Low of Nanyang Business School at Nanyang Technological University.

In our forthcoming Journal of Finance paper, Are Overconfident CEOs Better Innovators?, we find that over the 1993 to 2003 period, CEO overconfidence is associated with riskier projects, greater investment in innovation, and greater innovation as measured by the number of patent applications and patent citations even after controlling for the amount of R&D expenditures. In other words, the R&D investments of overconfident CEOs are more productive in generating innovation. However, greater innovative output of overconfident managers is achieved only in innovative industries. We also find evidence that overconfident CEOs are more effective at exploiting growth opportunities and translating them into firm value, especially within innovative industries. We find that overconfidence remains a strong and significant predictor of innovation even when we remove managers with short tenures at their firms, which suggests that the endogenous hiring of overconfident managers by innovative firms is not the main driver of our findings.

The results of this study have a bearing on the usual presumption that overconfidence is undesirable. Business commentators often point to examples of headstrong, overconfident CEOs who made disastrous decisions. However, the chance of a big defeat may be a corollary to the chance of great victory, so the lesson to draw from examples is unclear. A more serious charge is provided by the evidence of Malmendier and Tate (2008) that the market reacts more negatively to acquisitions made by overconfident CEOs. This dark side to CEO overconfidence might seem to suggest that the CEO selection process should be designed to filter out oversized egos, or that compensation and governance should be designed to severely constrain such CEOs.

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An “Entrepreneurial” and Restructured SEC Pledges Proactive Enforcement

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, April 5, 2012
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The following post comes to us from Jonathan Polkes, co-chair of the Securities Litigation Practice Group at Weil, Gotshal & Manges LLP, and is based on a Weil publication by Christian Bartholomew and Sarah Nilson, edited by Mr. Polkes and Mr. Bartholomew. The complete publication, including footnotes, is available here.

At the recent “SEC Speaks” conference in Washington, DC this year, Chairman Mary Schapiro and senior Enforcement officials vowed to increase investor protection through use of the SEC’s expanded authority under the Dodd-Frank Act and initiatives designed to help the SEC enforcement staff proactively detect and prevent securities law violations. In her speech, Schapiro pointed to numerous modernization initiatives as central to this effort, including better hiring, more training, more sophisticated IT systems, and better management structures. Schapiro noted that the Commission now has Wall Street traders, asset managers, and quantitative analysts on staff alongside attorneys, economists and accountants and has more than doubled its training budget since 2009. She also touted the SEC’s new TCR system (tips, complaints, and referrals) as allowing the SEC to better “triage” the information it receives and use that information more effectively in terms of opening new investigations, directing information to existing investigations, and uncovering and tracking emerging trends.

Schapiro pointed to the SEC’s record 735 enforcement actions, which returned more than $2 billion to investors, as evidence that these efforts to modernize the agency and bolster its knowledge base are already bearing fruit. Division of Enforcement Director Robert Khuzami echoed these remarks, saying that the agency’s risk-based initiatives are paying off and that the SEC is being more proactive, which has, in his view, resulted in more deterrence. Declaring a new “entrepreneurial” spirit and ethos, Schapiro and Khuzami made clear that the SEC intends to redouble its enforcement efforts across the board.

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Ten Additional Companies Disclose Management Declassification Proposals Made Pursuant to Agreements

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Wednesday, April 4, 2012
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Editor’s Note: Professor Lucian Bebchuk is the Director of the Harvard Law School Shareholder Rights Project (SRP), and Scott Hirst is the SRP’s Associate Director. Any views expressed and positions taken by the SRP and its representatives should be attributed solely to the SRP and not to Harvard Law School or Harvard University. An earlier post about the SRP’s activities is available here, a critique of the SRP’s activities by Martin Lipton and Theodore Mirvis is available here, and a response to this critique by Jeffrey Gordon is available here.

Since the Harvard Law School Shareholder Rights Project (SRP) issued its March 19 News Alert (reprinted in a post here), ten additional companies have made filings disclosing management proposals to declassify their boards made pursuant to agreements that these companies entered with institutional investors represented and advised by the SRP. With these ten additional companies, the number of companies that have made filings disclosing such management proposals during this proxy season – all listed here – has increased to 31.

During the 2011-12 proxy season, the SRP has been representing and advising several institutional investors – the Illinois State Board of Investment (ISBI), the Los Angeles County Employees Retirement Association, the Nathan Cummings Foundation (NCF), the North Carolina State Treasurer (NCDST), and the Ohio Public Employees Retirement System – in connection with the submission of shareholder proposals to over eighty S&P 500 companies with a staggered boards. The proposals urge a move to annual elections, which are widely viewed as corporate governance best practice.

Through active engagement with companies receiving declassification proposals, the SRP and the institutional investors working with the SRP have been able to reach negotiated outcomes with forty-three companies receiving such proposals (one additional company entered into an agreement since the March 19 News Alert). These forty-three companies have entered into agreements committing them to bring management proposals to declassify their boards.

The new companies disclosing management proposals made in accordance with such agreements (with the proponent submitting the shareholder proposal in parenthesis) are: C.H. Robinson Worldwide, Inc. (NCF); CenturyLink, Inc. (ISBI); Coventry Health Care, Inc. (ISBI); Flowserve Corporation (NCDST); FMC Technologies Inc (NCDST); Hudson City Bancorp, Inc. (NCF); Juniper Networks, Inc. (ISBI); O’Reilly Automotive, Inc. (NCF); Western Union (NCF); and Wyndham Worldwide Corporation (NCF). The full list of companies that have made filings disclosing management proposals made pursuant to agreements with institutional investors represented and advised by the SRP is available here. The list will be updated periodically as additional companies of those entering into agreements to bring management declassification proposals make such filings.

All of these companies, including the ten companies newly announcing management proposals, should be commended for their willingness to engage in a dialogue with shareholder proponents and their representatives and advisers – and for their responsiveness to shareholders’ preferences regarding classified boards.

Stock Options and Managerial Incentives for Risk Taking

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, April 4, 2012
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The following post comes to us from Rachel Hayes, Professor of Accounting at the University of Utah; Michael Lemmon, Professor of Finance at the University of Utah; and Mingming Qiu of the Department of Finance at the University of Utah.

In our forthcoming Journal of Financial Economics paper, Stock Options and Managerial Incentives for Risk Taking, we exploit the change in the accounting treatment of stock-based compensation under FAS 123R, which was issued by the Financial Accounting Standards Board (FASB) and took effect in December 2005, to provide new evidence on the role that convexity in compensation contracts plays in providing incentives for risk taking by managers.  An additional rationale that is often stated for the dramatic rise in option-based compensation over time revolves around how stock options were treated for accounting purposes. Prior to the implementation of FAS 123R, firms were allowed to expense stock options at their intrinsic value. Because nearly all firms granted stock options at-the-money, no expenses for option-based compensation were generally reported on the income statement.

Hall and Murphy (2003) argue that, due to their favorable accounting treatment and the fact that there is no cash outlay at the time of the grant, firms act as though the perceived cost of options is lower than their true economic cost. If firms make decisions based on the perceived costs instead of the economic costs, they grant more options than they would otherwise, and options with their favorable accounting treatment are preferred to possibly better incentive plans with less favorable accounting treatment. Consistent with this view, Carter, Lynch, and Tuna (2007) provide evidence that the accounting treatment of stock options affected their use, showing that a comprehensive proxy for financial reporting concerns was positively related to the use of stock options prior to FAS 123R. The implementation of FAS 123R eliminated the ability to expense options at their intrinsic value and instead required firms to begin expensing stock-based compensation at its fair value, effectively eliminating any accounting advantages associated with stock options.

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Wachtell Lipton’s Critique of Harvard Law School

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Tuesday, April 3, 2012
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Editor’s Note: Jeffrey Gordon is the Richard Paul Richman Professor of Law at Columbia Law School. This post relates to an earlier post by Martin Lipton and Theodore Mirvis, which is available here. Both this post and the Lipton-Mirvis post relate to the 2011-2012 work of the Harvard Law School Shareholder Rights Project, which is described in a post here.

The HLS Forum recently published a post by Martin Lipton and Theodore Mirvis titled “Harvard Shareholder Rights Project is Wrong.” The post was based on a memorandum issued by their law firm, Wachtell, Lipton, Rozen & Katz (“Wachtell”), and signed by the authors of the post and two other top partners at the firm. The memo and post offer a strongly worded critique of Harvard Law School for permitting the operation of the Shareholder Rights Project (SRP) clinical program. The objections were twofold: First, the results achieved by the clinic – agreements by 42 large public companies to propose charter amendments declassifying their boards – are undesirable as a public policy matter. Second, the clinic was wrong to represent public pension funds and charitable endowments because this representation went beyond “provid[ing] educational opportunities while benefiting impoverished or underprivileged segments of society for which legal services are not readily available.”

I think the Wachtell memo-writers’ strongly held belief about the virtue of classified boards as a governance feature of large public firms has spilled over into an unfair attack on the Harvard SRP clinic based on a straitjacketed conception of clinical legal education not followed by leading American law schools. Wachtell has, of course, long been known for its invention of the poison pill and its expertise in takeover defenses. Because staggered boards make poison pills more powerful and fortify takeover defenses, it is understandable that Wachtell, and some of the clients it serves, do not welcome large-scale declassification of boards. Whether such declassification would benefit shareholders and the American economy is a legitimate question for debate. However, criticizing Harvard Law School for permitting the SRP to operate should not be part of this debate.

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Considering Causes and Remedies for Declining IPO Volume

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Monday, April 2, 2012
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The following post comes to us from Jay R. Ritter, Cordell Professor of Finance at the University of Florida’s Warrington College of Business Administration. This post is based on Professor Ritter’s testimony before the Senate Committee on Banking, Housing, and Urban Affairs, available here.

I will first give some general remarks on the reasons for the low level of U.S. IPO volume this decade and the implications for job creation and economic growth, and then make some suggestions on the specific bills that the Senate is considering.

First, there is no doubt that fewer American companies have been going public since the tech stock bubble burst in 2000, and the drop is particularly pronounced for small companies. During 1980-2000, an average of 165 companies with less than $50 million in inflation-adjusted annual sales went public each year, but in 2001-2011, the average has fallen by more than 80%, to only 29 small firm IPOs per year. The patterns are illustrated in Figure 1.

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Insider Trading in Takeover Targets

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, April 2, 2012
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The following post comes to us from Anup Agrawal, Professor of Finance at the University of Alabama, and Tareque Nasser of the Department of Finance at Kansas State University.

In our paper, Insider Trading in Takeover Targets, forthcoming in the Journal of Corporate Finance, we provide systematic evidence on the level, pattern and prevalence of trading by registered insiders before announcements of takeovers during modern times. We examine insider trading in about 3,700 targets of takeovers announced during 1988-2006 and in a control sample of non-targets, both during an ‘informed’ and a control period. We analyze open-market stock transactions of five groups of corporate insiders: top management, top financial officers, all corporate officers, board members, and large blockholders. We separately examine their purchases, sales and net purchases in target and control firms during the one year period prior to takeover announcement (informed period) and the preceding one year (control) period, using a difference in differences (DID) approach. Using several measures of the level of insider trading, we estimate cross-sectional regressions that control for other determinants of the level of insider trading.

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SEC Enforcement to Focus on Private Equity Insider Trading and Conflicts of Interest

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Sunday, April 1, 2012
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The following post comes to us from Howard Sobel, partner and co-head of the US Private Equity Practice at Latham & Watkins LLP, and is based on a Latham & Watkins Client Alert by Mr. Sobel and Robert Burwell.

The private equity industry should expect increased scrutiny by the Securities and Exchange Commission (SEC), particularly with respect to insider trading and how firms address conflicts of interest, according to recent speeches by representatives of the SEC Division of Enforcement’s new Asset Management Unit. Moreover, The Wall Street Journal has reported that the SEC has “launched a wide-ranging inquiry into the private equity industry.” [1]

The Enforcement Division’s increasing attention to private equity corresponds with the implementation of new rules under the Dodd-Frank Act that will significantly increase the number of private equity firms subject to SEC regulation as “investment advisers.” The Asset Management Unit, one of a number of specialized enforcement units formed by the Division of Enforcement in 2010 to focus on “priority areas,” [2] is staffed with 65 professionals, including private equity experts.

Once registered as investment advisers, private equity firms must appoint a chief compliance officer and maintain written policies and procedures reasonably designed to prevent violation of the federal securities laws, including laws prohibiting insider trading. According to the SEC Staff, these policies and procedures should also promote compliance with firms’ fiduciary duties and regulatory obligations, including identifying and addressing conflicts of interest.

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