Monthly Archives: January 2013

FSA Calendar Year-End Update 2012

The following post comes to us from Paul Hinton, Vice President at NERA Economic Consulting, and is based on a NERA publication by Mr. Hinton, Robert Patton, and Zachary Slabotsky; the full document, including footnotes, is available here.

Fines imposed by the Financial Services Authority (FSA) since 1 January 2012 (through 20 December) have totalled £310 million, more than four times the total for 2011 (see Figure 1 below). This increase is due to a handful of very large fines, including the £160 million fine against UBS for LIBOR manipulation announced 19 December, which is the largest-ever FSA fine by a substantial margin.

The number of fines assessed against firms, 25, was in line with last year. In contrast, the number of fines against individuals fell to its lowest level since 2009, and the aggregate fine amount imposed on individuals fell slightly compared to 2011.

The dramatic increase in aggregate fines is the result of a few headline-grabbing penalties against banks, notably those against UBS and Barclays for manipulation of LIBOR and EURIBOR, and against UBS for failing to prevent unauthorised trading by a rogue trader, Kweku Adoboli. Those three fines alone totalled nearly £250 million. The size of fines against banks, of which there were nine in 2012 as compared to seven in 2011, largely explains the £244 million jump in the annual totals.

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EU Commission Proposes Action Plan for Corporate Governance

The following post comes to us from James R. Modrall, partner focusing on EU and international competition law at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum; the full publication, including footnotes, is available here.

On December 12, 2012, the European Commission published an Action Plan with initiatives it intends to undertake in 2013 in the fields of EU company law and corporate governance. These initiatives are primarily inspired by the responses to the Commission’s 2011 Green Paper on the EU corporate governance framework and an on-line consultation on the future of European company law. They are aimed at enhancing transparency, engaging shareholders and simplifying cross-border operations of EU companies. The Commission further plans to codify a number of major EU company law directives.

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A “Sea Change” in Public Pension Reporting on the Horizon

The following post comes to us from Michael A. Moran, Pension Strategist at Goldman Sachs Asset Management. This post is based on a Goldman Sachs white paper by Mr. Moran.

Executive Summary

Recently issued rules by the Governmental Accounting Standards Board (GASB) will notably change the way state and local governments account for and report the results of their defined benefit pension plans. Some plans may see their reported funded percentages fall under the new requirements. A plan’s funded status will now be reflected on the balance sheet, increasing transparency as well as the focus on measures that plan sponsors are taking to address these shortfalls. Funded status and pension expense measures are also likely to be more volatile under the revised reporting standards.

While the new GASB rules change some important aspects of public DB plan reporting, they do not change others. In particular, they neither mandate use of a lower discount rate for calculating liabilities nor higher contribution requirements. These are changes to accounting and financial reporting, not economics. Nonetheless, they do represent a notable change to the calculation and reporting of various pension-related metrics.

Some public DB plan sponsors are already facing significant challenges, such as relatively low funded levels. In addition, given budgetary challenges, some state and local governments do not have the flexibility to increase contributions at this time. All of this is occurring in an environment where long-term expected returns across a wide variety of asset classes have been falling. The GASB changes may add yet another layer of stress, if not complexity, for some public plan sponsors.

This paper reviews the following aspects of the GASB changes:

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Are Mutual Funds Active Voters?

The following post comes to us from Peter Iliev and Michelle Lowry, both of the Department of Finance at Penn State University.

In our paper, Are Mutual Funds Active Voters?, which was recently made publicly available on SSRN, we document that mutual funds vary significantly in how they fulfill their fiduciary duty to vote their shares in shareholders’ interests. Approximately 25% of mutual funds vote with ISS on nearly all company agenda items throughout our five-year sample period. However, many other mutual funds disagree frequently with ISS, particularly on contentious votes. We find that certain types of funds are more likely to find it optimal to incur the costs of evaluating the necessary information to independently assess the items up for vote. For example, large funds and funds from top 5 families can spread the costs over a wider asset base, and low turnover funds are more likely to own the stocks long enough to realize the valuation effects of the vote outcome and any consequent changes in company governance. We would thus expect such funds to be more likely to actively vote. A summary measure of fund activism, which is based on six fund characteristics, highlights the extent to which variation in funds’ costs and benefits of actively voting translates into dramatically different voting patterns. Across a sample of contentious compensation and governance votes, we find that passive funds follow ISS in 86% of the compensation and 77% of the governance votes, compared to analogous rates of only 15% and 19% among actively voting funds. Similarly, across a sample of contentious director votes, passive funds are approximately three times more likely than active funds to follow ISS.

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The JP Morgan “Whale” Report and the Ghosts of the Financial Crisis

Editor’s Note: Ben W. Heineman, Jr. is a former GE senior vice president for law and public affairs and a senior fellow at Harvard University’s schools of law and government. This post is based on an article that appeared in the Harvard Business Review online.

The apparition of 2008 returns once more. Two recently released JP Morgan Chase (JPM) reports on the causes of the “London Whale” trading losses raise important questions about whether financial service firms can exorcise the spectral issues which were so central to the financial crisis. They read as if JPM and a key headquarters unit — the Chief Investment Office — had not learned a single lesson from the meltdown four years ago. And unfortunately, they suggest that, in our huge, complex financial institutions, major failures of organizational discipline and major losses are likely to recur, despite greater attention to risk management.

These reports — one from a company task force and a second from a review committee of the board — were overshadowed by two items announced the same day: the related news that the bank board had slashed CEO Jamie Dimon’s annual compensation in half — from $23 million in 2011 to $11.5 million in 2012 — because of his “Whale-related” failures, and that JPM had posted a record 2012 net income of $21.3 billion.

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Federal Reserve Updates Consolidated Supervision Framework for Large Financial Institutions

H. Rodgin Cohen is a partner and senior chairman of Sullivan & Cromwell LLP focusing on acquisition, corporate governance, regulatory and securities law matters. This post is based on a Sullivan & Cromwell LLP publication by Aaron Nagano.

Summary

On December 17, 2012, the staff of the Federal Reserve issued a Supervision and Regulation (“SR”) letter describing the Federal Reserve’s new framework for consolidated supervision of large financial institutions. SR letters address significant policy and procedural matters related to the Federal Reserve’s supervisory responsibilities.

Under the new framework, the Federal Reserve’s primary supervisory objectives for large financial institutions will be (1) to enhance resiliency of an institution to lower the probability of its failure or its becoming unable to serve as a financial intermediary, and (2) to reduce the impact on the financial system and the broader economy of an institution’s failure or material weakness. These objectives are meant to conform to key provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, such as enhanced prudential standards for large financial institutions. Although the Federal Reserve has not previously stated these objectives as its primary supervisory objectives, and the new framework formally integrates areas such as corporate governance and compensation that Federal Reserve staff has been focused on since the financial crisis, changes in specific supervisory expectations are limited. Changes include greater emphasis on recovery planning in the case of financial or operational weakness, and on orderly resolution planning, as required by the Dodd-Frank Act. The Federal Reserve will also engage in greater “macroprudential” supervision to detect systemic risks.

The new framework applies to the largest and most complex financial institutions subject to consolidated Federal Reserve supervision, including nonbank financial companies designated by the Financial Stability Oversight Council for supervision by the Federal Reserve; other domestic bank and savings and loan holding companies with consolidated assets of $50 billion or more; and other foreign banking organizations with combined assets of U.S. operations of $50 billion or more.

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Checklist for Successful Acquisitions in the U.S.

Adam Emmerich is a partner in the corporate department at Wachtell, Lipton, Rosen & Katz focusing primarily on mergers and acquisitions and securities law matters. This post is based on a Wachtell Lipton firm memorandum by Mr. Emmerich, Robin Panovka, and other partners of Wachtell Lipton.

More than 40% of global M&A in 2012 involved acquirors and targets in different countries, including $170 billion of acquisitions in the U.S. by non-U.S. acquirors. Given the continuing accumulation of U.S. Dollars in emerging economies, many expect the trend to continue as Dollars are re-invested in the U.S. Natural resources will continue to be an important part of this story, including in the U.S., where substantial non-U.S. investment has been an important trend, as well as in resource-rich developed nations such as Canada and Australia, where non-domestic investment has lately been highly controversial.

Despite the empty election-year protectionist rhetoric in the U.S. last year, and continuing global concern over access to resources and technology by non-domestic actors, U.S. deal markets continue to be some of the most hospitable markets to off-shore acquirors and investors. With careful advance preparation, strategically thoughtful implementation and sophisticated deal structures that anticipate likely concerns, most acquisitions in the U.S. can be successfully achieved. Cross-border deals involving investment into the U.S. are more likely to fail because of poor planning and execution rather than fundamental legal or political restrictions.

Following is our updated checklist of issues that should be carefully considered in advance of an acquisition or strategic investment in the United States. Because each cross-border deal is different, the relative significance of the issues discussed below will depend upon the specific facts, circumstances and dynamics of each particular situation:

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2012 Year-End Securities Enforcement Update

Mark Schonfeld is a litigation partner at Gibson, Dunn & Crutcher LLP and co-chair of the firm’s Securities Enforcement Practice Group. This post is based on a Gibson Dunn client alert by Mr. Schonfeld and Kenneth J. Burke; the full version, including footnotes, is available here.

In many respects, 2012 was another year of aggressive SEC enforcement. The SEC’s Division of Enforcement again logged a near record number of enforcement actions. More important, the cases reflected a marked increase in the number and proportion of actions against registered investment advisers and broker-dealers, and their associated persons. This increased focus derives from a culmination of factors, including Enforcement’s creation of specialized units for the asset management industry and for structured products, the hiring of industry experts, and the close collaboration between staff from Enforcement and the SEC’s Office of Compliance Inspections and Examinations (“OCIE”). With the expansion of the registered private fund adviser population under financial reform legislation, and the launch of an initiative to conduct focused, risk-based examinations of these new registrants, this trend will likely continue for the foreseeable future.

At the same time, in the latter half of 2012 the SEC confronted significant challenges in litigating previously filed enforcement actions against individuals in cases related to the financial crisis. Whether these cases will cause the SEC to reevaluate its approach with respect to charging decisions in the future is unknown. However, in the short term, Enforcement seems undeterred by individual litigation results in its pursuit of continued enforcement actions.

The last six months of 2012 mark the beginning of another transition for the SEC generally, and for Enforcement in particular. As the year drew to a close, Mary Schapiro announced her departure as Chairman, followed by several division directors. Most notably, on January 9, 2013, the SEC announced that Robert Khuzami would step down as Director of Enforcement. As we look ahead to 2013, a new leadership team at the SEC and in Enforcement will seek to make their own imprint on the SEC’s priorities and processes. In addition, as more time has passed since the depth of the financial crisis, Enforcement’s priorities will shift to more recent conduct and emerging industry risks.

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“Don’t Ask, Don’t Waive Standstills” Revisited (Rapidly)

Trevor Norwitz is a partner in the Corporate Department at Wachtell, Lipton, Rosen & Katz, where he focuses on mergers and acquisitions, corporate governance and securities law matters. This post is based on a Wachtell Lipton firm memorandum by Mr. Norwitz, Igor Kirman, and William Savitt. 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.

In a second Chancery transcript ruling on the subject in recent weeks, Chancellor Leo E. Strine, Jr. has made clear that Delaware has no per se rule against “Don’t Ask, Don’t Waive” standstill provisions (which prohibit a party subject to a standstill, including a losing bidder in an auction, from requesting a waiver from its standstill obligations). The Chancellor also provided guidance for using such a provision as an “auction gavel” to secure the best price reasonably available to a target company involved in a sales process. The ruling in In Re Ancestry.com is a welcome clarification that will help maintain the vitality of auctions where a target wants to incentivize bidders to come forth with their highest bid.

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Corporate Governance and Value Creation

Viral Acharya is a Professor of Finance at New York University.

In the paper, Corporate Governance and Value Creation: Evidence from Private Equity, forthcoming in the Review of Financial Studies, my co-authors (Oliver Gottschalg, Moritz Hahn, and Conor Kehoe) and I attempt to bridge two strands of literature concerning PE, the first of which analyzes the operating performance of acquired companies, and the second that analyzes fund IRRs. In addition, we investigate how human capital factors are associated with value creation in PE deals. We focus on the following questions: (i) Are the returns to equity investments by large, mature PE houses simply due to financial leverage and luck or market timing from investing in well-performing sectors, or do these returns represent the value created at the enterprise level in the so-called portfolio companies, over and above the value created by the quoted sector peers? (ii) What is the effect of ownership by large, mature PE houses on the operating performance of portfolio companies relative to that of quoted peers, and how does this operating performance relate to the financial value created (if any) by these houses? (iii) Are there any distinguishing characteristics based on the background and experience of PE houses or partners involved in a deal that are best associated with value creation?

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