Monthly Archives: February 2013

Litigation of Investor Claims: State v. Federal Court

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, Eric M. Roth, William Savitt, and Warren R. Stern.

The Stanford Law School Securities Class Action Clearinghouse and Cornerstone Research recently released their analysis of securities class action filings in 2012. They report that 152 new securities class actions were filed last year, a 19 percent decline from the 188 new filings in 2011.

Of particular interest is the observation that only thirteen cases arising from merger and acquisition transactions were filed in federal courts in 2012, as compared to 43 in 2011 and 40 in 2010. “Evidence indicates,” the report states, that merger and acquisition litigation is “now being pursued almost exclusively in state courts after the unusual jump in federal M&A filings in 2010 and 2011.” Though such litigation typically arises under state law, plaintiffs often have the option to frame their claims as violations of the federal securities laws or bring them in federal court by invoking diversity jurisdiction.

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FINRA Proposes Disclosure of Recruitment Practices

The following post comes to us from Russell Sacks, partner at Shearman & Sterling in the Financial Institutions Advisory & Financial Regulatory Group, and is based on a Shearman & Sterling publication; the full text, including appendix, is available here.

On January 4, 2013, FINRA published Regulatory Notice 13-02, proposing a new FINRA rule (the “proposed rule”) in connection with the recruitment compensation practices of member firms. [1]

Introduction

In short, the proposed rule would:

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Risk Modeling at the SEC: The Accounting Quality Model

Editor’s Note: The following post comes to us from Craig M. Lewis, Chief Economist and Director of the Division of Risk, Strategy, and Financial Innovation at the U.S. Securities & Exchange Commission. This post is based on Mr. Lewis’s remarks at the Financial Executives International Committee on Finance and Information Technology, available here. The views expressed in this post are those of Mr. Lewis and do not necessarily reflect those of the Securities and Exchange Commission, the RSFI division, or the Staff.

The Division of Risk, Strategy and Financial Innovation, or “RSFI”, was formed, in part, to integrate rigorous data analytics into the core mission of the SEC. Often referred to as the SEC’s “think tank,” RSFI consists of highly trained staff from a variety of backgrounds with a deep knowledge of the financial industry and markets. We are involved in a wide variety of projects across all Divisions and Offices within the SEC and I believe we approach regulatory issues with a uniquely broad perspective.

Because my Division has a slightly cumbersome name – which is why you might hear us colloquially called “RiskFin” (though I prefer the more inclusive and accurate “RSFI,” as you can see) – today in my remarks I thought I’d focus on one word in our magisterial title: “Risk.” Risk, particularly as relates to the financial markets, can be a capacious term, and my Division certainly touches on many of those various meanings. But we are particularly focused on developing cutting-edge ways to integrate data analysis into risk monitoring.

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Guidance for Target Boards

Daniel E. Wolf is a partner at Kirkland & Ellis focusing on mergers and acquisitions. The following post is based on a Kirkland memorandum by Mr. Wolf and Sarkis Jebejian.

With litigation now an inevitable feature of the deal landscape, boards evaluating the sale of their company would be well-advised to understand the variety of claims that are being made by plaintiffs in these cases, and in particular those that have gained traction with the courts. While directors taking appropriate steps to address the underlying issues will by no means ensure that litigation will not be brought, the risk of an adverse outcome can be significantly reduced by advance preparation and proactive engagement. With the ever-changing nature of claims and creativity of the plaintiffs’ bar, the outline below is not intended to be exhaustive, but rather to offer some practical guidance to target boards as they structure their sale process.

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ISS, Glass Lewis, and the 2013 Proxy Season

John F. Olson is a founding partner of Gibson, Dunn & Crutcher’s Washington, D.C. office and a visiting professor at the Georgetown Law Center. The following post is based on a Gibson Dunn alert by Amy Goodman, Elizabeth Ising, Sean Feller, Gillian McPhee, Allison Balick and Kasey Levit Robinson.

Institutional Shareholder Services (“ISS”) and Glass, Lewis & Co., Inc. (“Glass Lewis”), the two major proxy advisory firms, recently released updates to their proxy voting policies for the 2013 proxy season. The ISS U.S. Corporate Governance Policy 2013 Updates (the “ISS Policy Updates”), which are available at http://issgovernance.com/policy/2013/policy_information, apply to shareholder meetings held on or after February 1, 2013. ISS also has released updated Frequently Asked Questions (the “ISS FAQs”), available at the link above, relating to its 2013 policies. The Glass Lewis Proxy Paper Guidelines for the 2013 Proxy Season (the “Glass Lewis Guidelines”) will be effective for annual meetings held on or after January 1, 2013. A summary of the updates to the Glass Lewis Guidelines is available here. This alert reviews the most significant ISS and Glass Lewis updates and suggested steps for companies to consider in light of these updated proxy voting policies.

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Ex-Ante Severance Pay Contracts and Optimal Executive Incentive Schemes

The following post comes to us from P. Raghavendra Rau, Professor of Finance at the University of Cambridge, and Jin Xu of the Finance Area at Purdue University.

In recent years, large severance payouts to executives who have been fired from poorly performing firms have attracted a great deal of attention in the popular press. There is a considerable degree of popular outrage on what seem to be egregious ex post payments that are unrelated to the executive’s performance during his tenure at the firm. However, though severance agreements are potentially important elements of executives’ compensation contracts, there is little empirical evidence on the incidence and terms of ex ante severance agreements negotiated by executives, let alone on how these contracts fit into executives’ overall incentive compensation schemes.

In our paper, How Do Ex-Ante Severance Pay Contracts Fit into Optimal Executive Incentive Schemes?, forthcoming in the Journal of Accounting Research, we analyze a unique hand-collected sample of 3,688 severance contracts in place at 808 firms in 2004. Based on the full list of S&P1500 firms, this sample is the most comprehensive of any work in this area, including firms of all sizes, ages, and industries, and executives of a wide range of ranks including the Chief Executive Officer (CEO), Chief Financial Officer (CFO), Chief Operating Officer (COO), and other executives. Around 68% of the firms list explicit severance contract terms with their executives. Most contracts list up to three sets of benefits: explicit cash payments as multiples of salary and bonus (most common benefit); medical and life insurance benefits, and benefits covering the payment of legal fees, outplacement, and other perks.

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2013 Compensation & Governance Outlook Report

The following post comes to us from David Chun, CEO and founder of Equilar, and is based on the executive summary of Equilar’s 2013 Compensation & Governance Outlook Report; the full publication is available here.

Each year, Equilar looks to highlight critical areas that can potentially affect those dealing with compensation and governance issues in the upcoming year. The 2012 Compensation & Governance Outlook Report aims to cover a variety of emerging trends in the fields of executive and director pay, equity trends, and corporate governance, while also providing an array of disclosure examples to illustrate unique approaches to strategic matters. The majority of firms will not encounter all, or even most, of the trends in this report in the New Year; it is primarily intended as a starting point for discussions that will take place over the course of 2013.

The 2012 year can be identified by a number of unique identifiers including the presidential election, high-profile public offerings, the second year of Say on Pay, record setting stock prices as well as an unfortunate natural disaster that helped bring together a country. Reverberations for such a dynamic year will no doubt be felt well into 2013 as potential changes to government and regulatory agencies could significantly alter the business landscape causing the need for firms to adjust. Discussions between companies and shareholders will continue to drive changes as firms ensure the story they want told is communicated through a variety of mediums and methods. Concerns surrounding fairness in a number of areas including stock structure and pay will cause struggles between conflicting parties as focus continues to shift towards the decisions in the boardroom. Topics including shareholder engagement, board dynamics, Say on Pay, and pay for performance dominate this year’s report.

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Governance Insights for 2012 — Canada

The following post comes to us from Berl Nadler, partner at Davies, Ward, Phillips & Vineberg LLP, and is based on the executive summary of a Davies publication by Carol Hansell, titled “Governance Insights 2012,” available here.

Executive Summary

In our annual review of the topics shaping governance today, we consider the ideas that will trend in boardrooms across Canada for months and years ahead. The dominant theme is the shareholder. Directors need look no farther than the events of 2012 to convince them that shareholders have the power to seize the governance agenda.

We believe that the first response of boards to shareholder activism is changing dramatically in light of recent events. Our section on the Power and Influence of Canadian Shareholders looks at the experience of three issuers (Canadian Pacific, Research in Motion and Magna) confronted by shareholder demands for governance change. In each case, the shareholders used different tools to effect change, and in each case they were successful. Boards in 2013 will incorporate the lessons learned from these situations in considering their own response to shareholder concerns with their governance practices.

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Rulemaking Petition Calls for Modernization of Section 13 Reporting Rules

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum by Mr. Lipton, Theodore N. Mirvis, Eric S. Robinson, Adam O. Emmerich, William Savitt, and Adam M. Gogolak.

NYSE Euronext, the Society of Corporate Secretaries and Governance Professionals and the National Investor Relations Institute have jointly filed a rulemaking petition with the SEC, seeking prompt updating to the reporting rules under Section 13(f) of the Securities Exchange Act of 1934, as well as supporting a more comprehensive study of the beneficial ownership reporting rules under Section 13. The petitioners urge the SEC to shorten the reporting deadline under Rule 13f-1 from 45 days to two business days after the relevant calendar quarter, and also suggests amending Section 13(f) itself to provide for reporting on at least a monthly, rather than quarterly, basis, to correspond with Dodd-Frank’s mandate for at least monthly disclosure of short sales. We applaud the petitioners for urging the SEC to modernize Section 13’s reporting rules, both with respect to Section 13(f) and more generally.

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Corporate Transparency on Bank Risk-Taking and Banking System Fragility

S.P. Kothari is a Professor of Accounting at the MIT Sloan School of Management.

The recent financial crisis and the ensuing economic slowdown have heightened the importance of better understanding the interconnectedness between the industrial and banking sectors. While several recent studies undertake this endeavor, the transmission mechanism in these studies is almost always from the banking sector to the industrial sector. In contrast, in our paper, The Effect of Industrial-Sector Transparency on Bank Risk-taking and Banking System Fragility, which was recently made publicly available on SSRN, my co-author (Sudarshan Jayaraman) and I provide evidence of the chain of causality working in the reverse direction, i.e., from the industrial sector to the banking sector. In particular, we document the important role that industrial-sector transparency plays in the efficient functioning of the banking sector. We argue that greater transparency in the industrial sector facilitates firms’ access to financing from capital markets and thus diminishes their reliance on banks. As a result, we expect banks to face increased competition in their product markets and to offset their lost rents by: (i) taking on more risk, (ii) reducing their cost structures, and (iii) increasing the intensity of intermediation.

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