Monthly Archives: March 2013

The Supply and Demand for Safe Assets

Gary Gorton is a Professor of Finance at Yale School of Management.

In the recent NBER working paper, my co-author, Guillermo Ordoñez of the University of Pennsylvania, and I develop a model to examine the important role collateral plays in the economy. Where do safe assets come from? Empirical evidence suggests that the private sector creates more near riskless assets when the supply of government debt is low and reduces privately-created near riskless assets when the supply of government debt is high. Krishnamurthy and Vissing-Jorgensen (2012) show that the net supply of government debt is strongly negatively correlated with the net supply of private near-riskless debt.

The substitution between public and private safe debt is also shown by Krishnamurthy and Vissing-Jorgensen (2012) who document that changes in the supply of outstanding U.S. Treasuries have large effects on the yields of privately created assets. Gorton, Lewellen, and Metrick (2010) also find this relationship between government debt and privately produced substitutes. They document that the share of safe assets in the U.S. economy, including both U.S. Treasury debt and privately created near-riskless debt has remained constant as a percentage of all U.S. assets since 1952. Xie (2012) shows that the issuance of asset-backed securities tends to occur when the outstanding government debt is low and Sunderam (2012) documents the same phenomenon with respect to asset-backed commercial paper.

By “safe assets,” we mean government debt and privately created high quality debt, in particular, asset-backed securities. Such safe assets are used to collateralize repo, derivative positions, and are needed as collateral in clearing and settlement. See IMF (2012). Further, because they are ”information-insensitive” (in the nomenclature of Dang, Gorton, and Holmstrom (2012)), they are highly liquid and hence can store value without fear of capital losses in times of stress, a form of private money.

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Delaware Federal Court Dismisses Say-on-Pay Case

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 a Wachtell Lipton memorandum by Mr. Katz, Warren R. Stern, and Kim B. Goldberg. 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.

Reaffirming that the advisory “say-on-pay” vote required by the Dodd-Frank Act cannot be used to attack directors’ executive compensation decisions, the United States District Court for the District of Delaware recently dismissed a derivative complaint brought after a negative say-on-pay vote. The court, applying Delaware law, found that the plaintiff had not pleaded facts sufficient to show that demand would have been futile, or to state a claim upon which relief could be granted. Raul v. Rynd, C.A. No. 11-560-LPS (D. Del. March 14, 2013).

The complaint was filed in 2011, and was one of a number of similar lawsuits filed after Dodd-Frank’s requirement for advisory votes on compensation came into effect. The plaintiff challenged the board’s compensation decisions, alleging that increased compensation in a year when the company posted a net operating loss and negative shareholder return violated the company’s pay-for-performance philosophy and rendered the company’s compensation disclosures in its proxy statement misleading. The plaintiff asserted that the negative shareholder advisory vote rebutted the presumption of business judgment surrounding the board’s compensation decisions.

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2013 Proxy Season Preview: Key Shareholder Proposals

The following post comes to us from Sean Di Somma, Senior Vice President for shareholder communication services at Alliance Advisors LLC, and is based on an Alliance Advisors whitepaper by Shirley Westcott. The full text, including footnotes, is available here.

The 2013 annual meeting season may lack the drama of last year’s Occupy protests and impending presidential election but it will still have its share of challenges for issuers. Revisions to proxy advisors’ pay models and peer groups are already spawning another round of supplemental proxies on Say-on-Pay (SOP), while threats of compensation disclosure strike suits have become this year’s unwelcome sideshow.

This spring also promises another big wave of shareholder resolutions, with over 600 filed to date, though for the most part they will repeat the prevailing themes seen in past years. Public pension funds and other institutional proponents are methodically cleaning up S&P 500 and Russell 2000 firms that still have classified boards and plurality voting in director elections. Meanwhile, retail activists are boosting their share of proposals calling for independent board chairmen and compensation reforms, in addition to their perennial filings on supermajority voting, special meetings, and written consent.

Based on submissions to date, several unexpected trends stand out. The first is a renewed blitz of resolutions on corporate campaign finance, particularly indirect lobbying activities, following the record spending in the 2012 election cycle. Although not likely to gain ground in support levels, proponents are clearly keeping up the momentum on this issue in the hopes of eventual SEC rulemaking mandating disclosure of political spending. Filings of compensation-related proposals have also escalated this year, though many of these were part of a now-abandoned campaign by the United Brotherhood of Carpenters (UBC) to promote triennial SOP votes.

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Canada Proposes Improvements in Early Warning Disclosure, Rights Plans

Theodore N. Mirvis is a partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz. The following post is based on a Wachtell Lipton memorandum by Mr. Mirvis, Eric S. Robinson, Adam O. Emmerich, William Savitt and Adam M. Gogolak. Posts regarding the Wachtell Lipton rule-making petition referred to in the post, and Wachtell Lipton’s forthcoming Harvard Business Law Review article on the subject, are available here and here. A post by Lucian Bebchuk and Robert Jackson regarding an article to which the Harvard Business Law Review article responds is available here. Other posts about blockholder disclosure and Schedule 13D are available here.

The Canadian Securities Administrators (CSA) recently proposed changes to Canada’s early warning regime for the disclosure of substantial blockholdings, including to lower the initial reporting trigger to 5% from 10%, to require disclosure no later than the opening of trading on the next business day, and to include equity equivalent derivatives and securities lending arrangements in the ownership calculation. Separately, the CSA proposed a new policy of greater flexibility as to rights plans, including in connection with unsolicited takeover bids. These proposals reflect sensible and necessary improvements to Canadian market regulation, to protect shareholders from the sorts of activist and takeover techniques and abuses that militate for changes in the U.S.’s Section 13(d) rules, and which, in the context of unsolicited takeover bids, the U.S. acceptance of rights plans have largely banished from the U.S.

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Perceived Bank Competition

The following post comes to us from Robert Bushman, Professor of Accounting at the University of North Carolina at Chapel Hill; and Bradley Hendricks and Christopher Williams, both of the Department of Accounting at the University of Michigan.

How competition affects firm performance is a central question of economics. As in other sectors, competitive pressure in the banking sector can influence the efficiency of bank operations, the quality of financial products, and the extent of innovation. However, unique to the financial sector is the potential link between competition and financial stability. Does bank competition promote financial stability or undermine it by creating incentives for excessive risk-taking? Further, assessing the influence of bank competition on risk-taking behavior is of critical importance to financial analysts, credit rating agencies and investors who seek to forecast banks’ future prospects. This task is perhaps more difficult in banking relative to other industries, given the wide-spread perception that banks are unusually opaque.

In our paper, Perceived Bank Competition: Operational Decision-Making and Bank Stability, which was recently made publicly available on SSRN, we utilize a bank-specific measure that extracts a bank’s perception of its competitive environment from a textual analysis of its 10-K filing. The premise is that managers’ perceptions of the competitive environment influence their operating and risk-taking decisions. We show that this measure is related to future operating performance and bank decision-making in ways that suggest it captures real competitive forces exerting pressure on banks.

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Second Circuit Orders Argentina to Submit a Payment Proposal

The following post comes to us from Antonia Stolper, head of the Capital Markets-Americas group and the Latin America affinity group at Shearman & Sterling LLP, and is based on a Shearman & Sterling client publication by Ms. Stolper, Henry Weisburg, Stephen J. Marzen, and Patrick Clancy.

The Second Circuit has ordered Argentina to submit a payment proposal, following oral argument in the NML v. Argentina appeal.

As we reported in a February 28 note, the three-judge panel of the Second Circuit expressed interest in whether an alternative Ratable Payment formula might be appropriate – one that would provide for equitable payments to the plaintiffs over time but would not amount to a 100% one time payment. At the oral argument, payment proposals made by counsel for both Argentina and the Exchange Bondholders were vague. Following up on those proposals, the panel ordered Argentina’s counsel to state “in writing” “the precise terms” of any “alternative payment formula and schedule to which it is prepared to commit.” The March 1, 2013 order provides in full as follows:

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SEC Enforcement Focusing on Valuation Issues

The following post comes to us from Jonathan Polkes, co-chair of the Securities Litigation Practice Group, and Christian Bartholomew, partner in the Securities Litigation and Complex Commercial Litigation practices, both at Weil, Gotshal & Manges LLP. This post is based on a Weil Gotshal alert by Mr. Bartholomew and Jill Baisinger.

Recently, the SEC’s Enforcement Division has brought three matters focused on alleged flaws (and fraud) in connection with valuation issues. Together these actions make clear that the SEC is and will be looking hard at how public companies as well as financial firms make difficult and subjective valuation decisions. Specifically, the SEC will be looking to see whether firms, and individuals, followed proper processes and applied the correct inputs in reaching these judgments. These cases also make clear that, even in times of significant market disruption, firms cannot ignore or substantially discount market inputs in making valuation judgment.

KCAP Financial

In November 2012, the SEC filed and settled In The Matter of KCAP Financial, Inc. This was the first action in which the SEC alleged that a public company had violated the provisions of Financial Accounting Standard (FAS) 157 by failing to properly value certain assets. FAS 157 requires expanded disclosures and incorporates a strong preference for market inputs to determine fair value. According to FAS 157, “[e]ven in times of market dislocation, it is not appropriate to conclude that all market activity represents forced liquidations or distressed sales.”

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SEC Expands Probe into Rule 10b5-1 Plans

The following post comes to us from William H. Hinman, Jr. and Daniel N. Webb, partners in the Corporate Department at Simpson Thacher & Bartlett LLP. This post is based on a Simpson Thacher memorandum by Mr. Hinman and Mr. Webb.

Recent press stories have revived speculation that corporate insiders may be abusing rule 10b5-1 trading plans to reap unfair profits from inside knowledge of their companies. [1] The SEC is reported to have expanded its probe beyond trades highlighted by the press to cover a larger range of executive trading activity. [2] Other regulators have launched their own investigations, and investor groups have joined the conversation. [3]

In light of this widespread and intensifying scrutiny, companies and executives should consider techniques that make it easier to demonstrate compliance with the requirements of rule 10b5-1, such as:

  • having the first trade under a 10b5-1 plan take place after some reasonable “seasoning period” has passed from the time of adoption of the plan,
  • having each executive use only one 10b5-1 plan at a time, and
  • minimizing terminations and amendments of 10b5-1 plans.

The current controversy centers on trading by executives under 10b5-1 plans that, in hindsight, appears “well-timed.” Much like in the stock option pricing controversy from a few years ago, the press and some analysts have employed a retrospective statistical analysis of 10b5-1 plan trades to argue that insiders using the plans seem to be doing surprisingly well.

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Corporate Law and Economic Stagnation

The following post comes to us from Pavlos E. Masouros, Assistant Professor of Corporate Law at Leiden University.

The book, “Corporate Law and Economic Stagnation: How Shareholder Value and Short-termism Contribute to the Decline of the Western Economies” (Eleven International Publishers, 2013), introduces three hypotheses that put corporate law on the map of the causes of the current economic crisis and introduces a normative legal concept, “Long Governance” that can help take the economy out of the slump. Overall, the author takes a post-Keynesian approach to the theory of the firm and uses political economy analysis to expose corporate law’s contribution to a stagnating economy in the West.

The breakdown of the Bretton Woods monetary order in the early 1970s triggered a chain of political, economic and legal events that incrementally brought about “the Great Reversal in Corporate Governance”, i.e. the reorientation of corporate governance from the institutional logic of “retain and invest” to the logic of “downsize and distribute”, and “the Great Reversal in Shareholdership”, i.e. the shortening of the time-horizons of shareholders.

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Court Issues FCPA Rulings Regarding Foreign Business Executives

Joseph Warin is partner and chair of the litigation department at the Washington D.C. office of Gibson, Dunn & Crutcher. This post is based on a Gibson Dunn client alert by Seema Gupta and Avi Weitzman.

In the past two weeks, Judges Richard J. Sullivan and Shira A. Scheindlin of the United States District Court for the Southern District of New York separately issued important rulings in civil Foreign Corrupt Practices Act (“FCPA”) cases against foreign executives of non-U.S.-based companies whose stock is traded on a U.S. stock exchange. Their rulings reached opposite results on the issue of the court’s exercise of personal jurisdiction over foreign executives who are alleged to have violated the FCPA. One or both of these rulings could provide the Second Circuit with a rare opportunity to clarify the FCPA’s jurisdictional reach in the context of purely foreign bribery schemes.

SEC v. Straub, __ F. Supp. 2d __, No. 11 Civ. 9645 (RJS) (Feb. 8, 2013) (Sullivan, J.)

In December 2011, the Securities and Exchange Commission (“SEC”) brought a civil enforcement action against three senior executives of a Hungarian telecommunications company, Magyar Telekom, who allegedly bribed government and political party officials in Macedonia and Montenegro in 2005 and 2006 to win business and shut out competition in the telecommunications industry. The SEC alleges that these executives used sham “consultancy” and “marketing” contracts to pay approximately €4.875 million to Macedonian officials and €7.35 million to Montenegrin officials. The three executives then allegedly caused the bribes to be falsely recorded in Magyar’s books and records, which were consolidated into the books and records of its parent company, Deutsche Telekom AG. Both Magyar and Deutsche Telekom were publicly traded through American Depository Receipts (“ADRs”) on the New York Stock Exchange (“NYSE”). The defendants allegedly made false certifications to Magyar’s auditors, who in turn provided unqualified audit opinions that accompanied the filing of Magyar’s annual reports with the SEC. There was no allegation that any of the negotiations or meetings regarding this scheme occurred within the United States, that the payment of bribes occurred through banks located in the United States, or that the foreign defendants otherwise ever traveled to the United States in furtherance of the bribery scheme.

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