Monthly Archives: March 2013

Shareholder Proxy Access in Small Publicly Traded Companies

J.W. Verret is an Assistant Professor at George Mason University School of Law.

In Business Roundtable v. SEC, the DC Court of Appeals struck down the proxy access rule giving certain shareholders access to the corporate proxy on the grounds that the SEC failed to adequately fulfill its requirement to consider the impact of new rules on “efficiency, competition, and capital formation.” The Court offered a blistering critique of the SEC’s economic analysis in the rule. Criticism of the opinion followed and also led to a series of Congressional hearings on the SEC’s process for weighing the economic costs and benefits of new rules. Many of the critics of the opinion, and indeed of cost-benefit analysis itself, have argued that it is simply too difficult to guide rulemaking, or that costs are easier to measure than benefits and so the approach trends against the status quo.

I counter that critique of Business Roundtable by way of example in an article co-authored with Thomas Stratmann in the Stanford University Law Review, Does Shareholder Proxy Access Damage Share Value in Small Publicly Traded Companies? We suggest a question the SEC might itself have investigated about its approach, if it had submitted a rule proposal first and if it was committed to economic analysis of its rules. We consider a natural experiment provided by the rule’s differential impact on small and large firms above and below the arbitrary $75 million market capitalization separation. We measure the impact of the market’s frustrated expectation of a permanent exemption for small firms, an expectation stemming from prior SEC implementation of other controversial rules and strong language in the Dodd-Frank Act, against a control group represented by large firms who expected application of the rule and for whom the new rule’s impact was largely capitalized into their value.


Board Composition and Firm Value — Lessons from Lawyer-Directors

The following post comes to us from Charles K. Whitehead, Professor of Law at Cornell Law School.

Within the standard framing, directors monitor managers in order to help align shareholder-manager interests and minimize the agency costs that arise within public companies. A principal goal has been to reinforce director independence in light of the conventional wisdom that independent directors are the most effective monitors. Directors, however, are more than just agency-cost-reducers. As managers, they also bring to bear different perspectives and judgments that are important in formulating business strategies. In addition, their training, expertise, and experience in problem-solving are valuable in managing a business, as well as their knowledge of markets and practices that may be less familiar to firm executives.

The board’s managing function has been under-evaluated by law and finance academics. In our working paper, Lawyers and Fools: Lawyer-Directors in Public Corporations, my co-authors, Lubomir Litov and Simone Sepe, and I offer new insight into how boards operate. Specifically, we analyze the effect on firm value of directors with legal training (“lawyer-directors”) who sit on the boards of public, non-financial corporations.


Court: Disclosure of SEC Investigation Insufficient to Plead Loss Causation

The following post comes to us from Adam Hakki, partner and global head of the Litigation Group at Shearman & Sterling LLP, and is based on a Shearman & Sterling client publication.

The US Court of Appeals for the Eleventh Circuit recently issued an important decision that addresses two types of allegations that plaintiffs routinely rely on to plead loss causation in federal securities fraud cases. In Meyer v. Greene, 2013 US App. LEXIS 4187 (11th Cir. Feb. 25, 2013), the Eleventh Circuit appears to have become the first federal court of appeals to rule definitively that the mere announcement of an investigation by the US Securities and Exchange Commission (“SEC”) followed by a decline in a company’s stock price is insufficient to plead loss causation. The Court also ruled, consistent with decisions from other federal circuits, that a negative third-party analyst presentation is not a corrective disclosure for purposes of pleading loss causation if the presentation is based on publicly available information.


Governance Buffett Style

The following post comes to us from Lawrence A. Cunningham, Henry St. George Tucker III Research Professor of Law at George Washington University Law School. This post is based on and adapted from The Essays of Warren Buffett: Lessons for Corporate America (3d ed. 2013) by Professor Cunningham.

In Warren Buffett’s model of corporate governance, managers are stewards of shareholder capital. The best managers think like owners in making business decisions. They have shareholder interests at heart. But even first-rate managers will sometimes have interests that conflict with those of shareholders. How to ease those conflicts and to nurture managerial stewardship have been constant objectives of Buffett’s long career and a prominent theme of his shareholder letters that I began collecting two decades into the stand-alone book, The Essays of Warren Buffett: Lessons for Corporate America, the third edition of which was released in March 2013.

The essays address some of the most important governance problems. The first is the importance of forthrightness and candor in communications by managers to shareholders. Buffett tells it like it is, or at least as he sees it, and laments that he is in the minority. Berkshire’s annual report is not glossy; Buffett prepares its contents using words and numbers people of average intelligence can understand; and all investors get the same information at the same time. Buffett and Berkshire avoid making predictions, a bad managerial habit that too often leads other managers to make up their financial reports.


The Board, Social Media and Regulation FD

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 widespread use of social media in today’s global marketplace presents opportunities and challenges for all financial market participants, including boards of directors, investors and regulators. While social media outlets provide unprecedented pathways for companies to engage actively with investors, both large and small, as well as with reporters, analysts, customers, suppliers and other members of the corporate community, there are regulatory restrictions that public companies need to heed. Releasing information via Twitter, Facebook, and similar channels must be done with caution to avoid violating Securities and Exchange Commission (SEC) Regulation FD as it currently stands. Moreover, companies are vulnerable to negative publicity that can be quickly and widely disseminated over social media networks, even if they are not active participants in such channels.

As public companies increasingly use and rely upon the new avenues of communication provided by social media, it is correspondingly important for directors to be aware of the manner and extent of their companies’ use of social media and have a basic understanding of the risks and benefits of corporate participation. At the same time, it may be incumbent upon the SEC to revisit Regulation FD. The immediacy and availability of communications made through social media suit the purpose of Regulation FD far better than anything available at the time of its passage in 2000; by failing to update Regulation FD, the SEC may find that the rule is impeding rather than furthering its stated goals. Fundamentally, the interests of all market participants are aligned when it comes to encouraging companies to use social media consistently, effectively, and legally, as enhanced transparency and increased engagement generally benefit the market as a whole.


The Uneasy Case for Favoring Long-term Shareholders

Jesse Fried is a Professor of Law at Harvard Law School.

The power of short-term shareholders in widely-held public firms is widely blamed for “short-termism”: directors and executives feel pressured to boost the short-term stock price at the expense of creating long-term economic value. The recent financial crisis, which many attribute to the influence of short-term shareholders, has renewed and intensified these concerns.

To reduce short-termism, reformers have sought to strengthen the number and power of long-term shareholders in public corporations. For example, the Aspen Institute has recommended imposing a fee on securities transactions and making favorable long-term capital gains rates available only to investors that own shares for much longer than a year. Underlying these proposals is a long-standing and largely uncontested belief: that long-term shareholders, unlike short-term shareholders, will want managers to maximize the economic pie created by the firm.

I recently posted a paper on SSRN explaining why this rosy view of long-term shareholders is wrong. In my paper, The Uneasy Case for Favoring Long-term Shareholders, I demonstrate that long-term shareholder interests do not align with maximizing the economic pie created by the firm – even when shareholders are the only residual claimants on the firm’s value. In fact, long-term shareholder interests might be less well aligned with maximizing the economic pie than short-term shareholder interests. In short, we can’t count on long-term shareholders to be better stewards of the firm simply because they hold their shares for a longer period of time.


Assessing Vague Shareholder Proposals Under Rule 14a 8(i)(3)

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; Amy L. Goodman is a partner and co-chair of the Securities Regulation and Corporate Governance practice group at Gibson, Dunn & Crutcher LLP. The following post is based on a Gibson Dunn alert by Ms. Goodman, Elizabeth Ising, Brian Lane, and Ronald Mueller.

During the 2012 proxy season, the SEC staff concurred that a number of high profile shareholder proposals could be excluded from company proxy statements because various key terms in the proposals were not adequately defined or explained within the text of the proposal and supporting statement. See e.g., WellPoint, Inc. (SEIU Master Trust) (avail. Feb. 24, 2012, recon. denied Mar. 27, 2012) (concurring with exclusion of an independent chair proposal that referred to the New York Stock Exchange standard of independence without defining it because “neither shareholders nor the company would be able to determine with any reasonable certainty exactly what actions or measures the proposal requires”); Textron Inc. (avail. Mar. 7, 2012) (arguing that a reference to the Rule 14a-8 eligibility requirements in a proxy access shareholder proposal was vague and indefinite, although the staff ultimately concurred with the exclusion of the shareholder proposal on other grounds); Dell Inc. (avail. Mar. 30, 2012) (concurring with the exclusion of a similar proxy access shareholder proposal because the proposal’s reference to the Rule 14a-8 eligibility requirements was vague and indefinite). While these no-action letters reflected long-standing SEC staff precedent, in the current proxy season, there has continued to be a large number of no-action requests arguing that various terms in shareholder proposals are undefined or vague and therefore excludable under Rule 14a-8(i)(3).


Emerging Challenges for Regulating Global Capital Markets

Daniel M. Gallagher is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Gallagher’s keynote address at the Symposium on Building the Financial System of the 21st Century: An Agenda for Europe and the United States. The full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Gallagher and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

We in America have been blessed with a wonderful combination of geography, natural resources, and free market principles. These and other factors have allowed our economy and our financial system, including our capital markets, to thrive in the post-World War II era.

Although the United States has suffered its share of financial crises, most recently the one that erupted in 2008, our free market economy and robust capital markets have conferred an enviable prosperity on our people over a period of many years, and few in America can remember a time when the United States did not have strong and competitive capital markets.

However, the very strength and resilience of our capital markets could lead us to fall into the trap of believing that we are somehow entitled to such prosperity. Indeed, such a sense of complacency may well have taken root in our government and may threaten to jeopardize that prosperity. The reality is that we live in a world in which we must be constantly vigilant — sometimes taking affirmative action, but more often choosing not to act — in order to preserve the vitality of our markets.

An important part of my job, and that of my colleagues on the Commission, is to ensure that America’s capital markets remain strong, vibrant, and competitive. That’s not just good for U.S. investors, but also for other investors around the world. And, conversely, the rise of robust capital markets in other parts of the world has the potential to benefit the United States and the American people as well.


Proposed NASDAQ Rule Requires Internal Audit Function at Listed Companies

Boris Feldman is a member of Wilson Sonsini Goodrich & Rosati, P.C. This post is based on a WSGR alert.

The NASDAQ Stock Market LLC (Nasdaq) recently filed with the Securities and Exchange Commission (SEC) a proposed rule [1] requiring listed companies to establish and maintain an internal audit function. [2] The SEC is soliciting comments on the proposed rule through March 29, 2013. [3]

Under the proposed rule, the internal audit function would be required to provide management and the audit committee with ongoing assessments of the company’s risk management processes and system of internal control. In addition, new Rule 5645 would require the audit committee to:

  • meet periodically with the company’s internal auditors (or other personnel responsible for this function); and
  • discuss with the outside auditors the responsibilities, budget, and staffing of the company’s internal audit function.

Companies would be permitted to outsource their internal audit function to a third-party service provider other than their independent auditor. For companies that choose to outsource this function, Nasdaq has stated that the company’s audit committee maintains sole responsibility to oversee the internal audit function and may not allocate or delegate this responsibility to another board committee.

According to Nasdaq, the proposed rule is designed to:


Breaking Down FINRA’s Revised Proposed Fixed-Income Research Rule

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 appendices, is available here.

In the fourth quarter of 2012, FINRA published Regulatory Notice 12-42 (the “Revised Proposal”), amending its proposal for substantive regulation of fixed-income research by FINRA-member firms. [1] The Revised Proposal represents the revision of FINRA’s earlier proposal, and modifies that proposal in meaningful ways. [2]

Executive Summary:

The Revised Proposal amends FINRA’s earlier proposal. In particular, the Revised Proposal:


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