Monthly Archives: November 2013

Another Salvo on SEC Penalties

John F. Savarese and Wayne M. Carlin are partners in the Litigation Department of Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Savarese, Mr. Carlin, Theodore A. Levine, and David B. Anders.

SEC Commissioner Luis Aguilar recently spoke against a policy statement concerning corporate penalties that was issued in 2006 by the then-sitting Commissioners. The 2006 statement emphasized two principal considerations: (1) did the corporation receive a benefit from the misconduct; and (2) will a penalty recompense or further harm injured shareholders? Commissioner Aguilar characterized the 2006 statement as “fatally flawed” and noted approvingly that SEC Chair Mary Jo White recently noted that it is not a binding policy. Commissioner Aguilar argued that considering whether there was a benefit to the corporation distracts a penalty analysis from its proper focus—namely, the nature of the misconduct. While the nature of any misconduct is always a relevant and important consideration in determining the appropriate penalty, the statute authorizing penalties does make it relevant to consider whether the corporation received a benefit.

As we have noted before, the Commission’s civil penalty authority is limited by statutory language. The statute provides for three tiers of penalties in escalating amounts. In a time when corporate penalties in the tens or even hundreds of millions of dollars are criticized as inadequate or worse, it can be easy to lose sight of the fact that the maximum corporate penalty under the statute is currently $775,000 per violation. While the “per violation” language is where creative SEC math can sometimes come into play, as we have noted, some federal judges in litigated cases have followed a more measured approach. See our memo, SEC Penalties: Getting Tougher, and Remembering Some History, from October 17, 2013.


Remarks to the Independent Directors Council Annual Fall Meeting

The following post comes to us from Norm Champ, director of the Division of Investment Management at the U.S. Securities and Exchange Commission. This post is based on Mr. Champ’s remarks at an Independent Directors Council Annual Fall Meeting; the full text, including footnotes, is available here. The views expressed in this post are those of Mr. Champ and do not necessarily reflect those of the Securities and Exchange Commission, the Division of Investment Management, or the Staff.

It is a privilege to appear before a group that is so important to the strength and integrity of the fund industry. Independent directors have significant responsibilities, and it requires tremendous effort and time on your part to do your job well. I applaud your efforts to learn from the professionals who are participating in this conference. The insights of the panels you heard yesterday and this morning, and those you will hear after lunch will provide valuable information.

The importance of mutual funds in the lives of American investors is clear. Mutual funds hold close to $14 trillion of the hard earned savings of over 53 million American households. The majority of Americans access the markets through mutual funds. They invest in funds, and hope their investments will grow, for many reasons—to make a down payment on a house, to save for a college education, and ultimately to pay for a retirement.


Does Fair Value Accounting Contribute to Procyclical Leverage?

The following post comes to us from Amir Amel-Zadeh of Judge Business School at the University of Cambridge; Mary Barth, Professor of Accounting at Stanford University; and Wayne Landsman, Professor of Accounting at the University of North Carolina.

Many academic researchers, policy makers, and other practitioners have concluded that fair value accounting can lead to suboptimal real decisions by firms, particularly financial institutions, and result in negative consequences for the financial system. This conclusion is sustained by the belief that fair value accounting was a major factor contributing to the 2008-2009 financial crisis by causing financial institutions to recognize excessive losses, which in turn caused excessive sales of assets and repayment of debt, thereby leading to procyclical accounting leverage. Leverage is procyclical when it decreases during economic downturns and increases during economic upturns. In our paper, Does Fair Value Accounting Contribute to Procyclical Leverage?, which was recently made publicly available on SSRN, we examine whether there exists any link between fair value accounting and procyclical accounting leverage.

To address this question, we develop a model of commercial bank actions taken in response to economic gains and losses on their assets throughout the economic cycle to meet regulatory leverage requirements. We focus on commercial banks because of the central role they play in the financial system and the allegation that their actions in response to fair value losses contributed to the financial crisis. Our model and empirical tests based on the model establish that procyclical accounting leverage for commercial banks only arises because of differences between regulatory and accounting leverage, and not because of fair value accounting.


Developments Regarding Gender Diversity on Public Boards

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.

While the number of women directors on U.S. public company boards has not risen dramatically since 2012, the issue of gender diversity on boards continued to gain momentum and global prominence over the last 12 months. Since we last discussed this issue, new legislative and non-governmental initiatives around the world have resulted in growing numbers of women directors and greater shareholder focus on board diversity and related disclosures. This issue is likely to become increasingly significant in 2014 and beyond, both in the United States and abroad.

EU Developments

Earlier this month, the European Commission moved a step closer to imposing a form of gender quota on major public companies in the European Union. Two committees of the European Parliament voted in favor of a proposal by the European Commission to require certain public companies to increase the representation of women on their boards. The proposed law applies only to large public companies, with no exceptions even for companies in which women compose less than 10 percent of the workforce, and, if adopted, provides for obligatory sanctions for failure to follow the proposed requirements.


2013 Annual Corporate Governance Review

The following post comes to us from David Drake, President of Georgeson Inc., and is based on the Executive Summary of a Georgeson report. The complete publication is available here.

For many years, the proactive engagement of shareholders on corporate governance matters has been limited to just a handful of companies. However, over the past few years companies have shown a greater willingness to engage, particularly after the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) made advisory votes on executive compensation (commonly referred to as “say-on-pay”) a mandatory voting item for most publicly traded U.S. companies. Last year we reported on the explosive growth in the level of engagement between public companies and investors on corporate governance matters, with both sides lauding the benefits of such engagement. Investors’ proxy departments have reported the benefits of gaining an early understanding of the issues a company is facing and the rationale behind decisions the company made beyond what is disclosed in the proxy statement. Meanwhile, issuers have found value in gaining firsthand knowledge of the nuances of investors’ proxy voting guidelines.

Given that both sides have seen the benefits of such an exchange, there has again been a significant rise in the number of engagement programs initiated by companies this year. As one would expect, there were a variety of reasons that companies sought to engage in outreach campaigns. While most companies engaged in order to improve on their past voting results, many others have aimed to establish a dialogue in order to maintain positive results. The scope of programs also tended to vary with many being quite expansive. These included lengthy off-season engagements with institutions, multiple contacts with the same institution during the year, in-person visits with investors and inclusion of members of the board of directors in the discussion. Some companies went so far as to proactively reach out to their top 100, 150 and even 200 institutional investors.


The Autonomous Board

John Wilcox is chairman of Sodali, a co-chair of, and former Head of Corporate Governance at TIAA-CREF. This post is based on a Sodali publication by Mr. Wilcox.

“Can we end the long tradition of the boardroom as a sealed chamber…? Can we move toward more transparency about the boardroom process…?”
—Leon Panetta

Companies preparing for their annual shareholder meetings in 2014 should be aware of a new governance challenge: opposition to the election of individual directors is becoming a strategy of choice not only for activists but for “responsible” investors seeking change at portfolio companies. Withholding (or threatening to withhold) votes for incumbent directors, supporting short slate campaigns, or voting for dissident candidates in proxy contests are no longer considered hardball tactics for use only in extreme cases. Institutional investors who in the past would routinely support incumbent directors have learned an important lesson from the success of hedge funds and activists: targeting directors gets the immediate attention of companies, promotes dialogue, attracts media coverage and increases pressure on other investors to support shareholder initiatives.


FINRA Issues Report on Broker-Dealer Conflicts of Interest

Annette Nazareth is a partner in the Financial Institutions Group at Davis Polk & Wardwell LLP, and a former commissioner at the U.S. Securities and Exchange Commission. The following post is based on a Davis Polk client memorandum.

On October 14, 2013, FINRA issued a Report on Conflicts of Interest. The report summarizes FINRA’s observations following an initiative, launched in July 2012, to review conflict management policies and procedures at a number of broker-dealer firms. The report focuses on approaches to identifying and managing conflicts of interest in three broad areas: enterprise-level conflicts governance frameworks; new product conflicts reviews; and compensation practices.

While the report does not break new ground or create or alter legal or regulatory requirements, it offers insight into the approach that FINRA expects firms to take in implementing a robust conflict management framework. In particular, the report identifies effective practices that FINRA observed at various firms. Broker-dealers should use this report as a basis for reviewing and potentially strengthening their policies and procedures relating to managing conflicts of interests.


FDIC Cautions Financial Institutions Regarding Increase in D&O Insurance Exclusions

The following post comes to us from John Dugan, partner and chair of the Financial Institutions Group at Covington & Burling LLP, and is based on a Covington & Burling E-Alert.

The FDIC last week issued a Financial Institution Letter advising financial institutions and their directors and officers of the increased use of exclusionary terms or provisions in D&O policies, and the resulting increased risk of uninsured personal civil liability for directors and officers. (FIL-47-2013, October 10, 2013).

The FDIC Letter urges the directors of financial institutions to make well-informed choices about D&O coverage, including consideration of costs and benefits, exclusions and other restrictive terms in proposed policies, and the implications for personal financial liability for directors and officers.

D&O insurance is a critical asset for financial institutions and their directors and officers, and the FDIC Letter expressly affirms that the purchase of D&O insurance serves a valid business purpose. The FDIC’s Letter is also a timely reminder that the D&O insurance market is in constant flux and that—in addition to seeking advice from insurance brokers—directors should consider seeking advice from experienced coverage counsel to gain a better understanding of the potential impact of restrictive provisions in proposed policies.


Creeping Takeovers and Fiduciary Duties—A Recap

The following post comes to us from Spencer D. Klein, partner in the Corporate Department and co-chair of the global Mergers & Acquisitions Group at Morrison & Foerster LLP, and is based on a Morrison & Foerster publication. 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 In re Sirius XM Shareholder Litigation, [1] Delaware Chancellor Strine dismissed a complaint that the Sirius board had breached its fiduciary duties by adhering to the provisions of an investment agreement with Liberty Media that precluded the Sirius board from blocking Liberty Media’s acquisition of majority control of Sirius through open-market purchases made by Liberty Media following a three-year standstill period. By holding the complaint to be time-barred under the equitable doctrine of laches the Delaware court did not address the merits of whether the Sirius board breached its fiduciary duties. However, In re Sirius still offers the opportunity to recap the guidance on “creeping takeovers” that can be derived from existing Delaware case law:


Third Circuit Panel Strikes Down Court of Chancery’s Confidential Arbitrations

The following post comes to us from Frederick H. Alexander, Chair of the Executive Committee and partner in the Delaware Corporate Law Counseling Group at Morris, Nichols, Arsht & Tunnell LLP. The following post is based on a Morris Nichols publication by Mark Hurd and John DiTomo. 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.

A three-judge panel of the U.S. Court of Appeals for the Third Circuit—issuing three opinions, a majority, concurrence, and dissent—today [Oct. 23, 2013] affirmed a district court ruling enjoining the Delaware Court of Chancery’s arbitration program. Click here to download a copy of the Court’s opinion.

In 2009, the Delaware General Assembly enacted legislation empowering sitting judges of the Court of Chancery to arbitrate private business disputes so long as one party is a Delaware entity, neither party is a consumer, and the amount in controversy exceeds $1 million (“Chancery Arbitrations”). Like most private arbitrations, Chancery Arbitrations are conducted confidentially. In 2011, the Delaware Coalition for Open Government challenged the constitutionality of Chancery Arbitrations, arguing that because the proceedings are conducted in private, the program violated the First and Fourteenth Amendments of the U.S. Constitution, which guarantee a right of public access to certain government proceedings. In 2012, the district court enjoined the members of the Court of Chancery from conducting Chancery Arbitrations, concluding that the proceedings were no different than civil trials to which a right of public access extended. The Chancellor and Vice Chancellors appealed the decision.


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