Yearly Archives: 2013

Corporate Short-Termism – In the Boardroom and in the Courtroom

Posted by Mark Roe, Harvard Law School, on
Friday, April 26, 2013
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Mark Roe is the David Berg Professor of Law at Harvard Law School, where he teaches bankruptcy and corporate law.

Last month I posted to SRRN Corporate Short-Termism – In the Boardroom and in the Courtroom, which the Business Lawyer will publish this August.

In this paper, I examine a long-held view in corporate circles has been that furious rapid trading in stock markets has been increasing in recent decades, justifying more judicial measures that shield managers and boards from shareholder influence, so that boards and managers are freer to pursue sensible long-term strategies in their investment and management policies.

However, when I evaluate the evidence in favor of that view, the evidence turns out to be insufficient to justify insulating boards from markets further. While there is evidence of short-term distortions, the view is countered by several under-analyzed aspects of the American economy, each of which alone could trump the board isolation prescription. Together they make the case for further judicial isolation of boards from markets untenable.

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Preferring Foreign Depositors

Posted by Bradley K. Sabel, Shearman & Sterling LLP, on
Friday, April 26, 2013
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Bradley Sabel is partner and co-head of the Financial Institutions Advisory & Financial Regulatory practice group at Shearman & Sterling LLP. This post is based on a Shearman & Sterling client publication.

The Federal Deposit Insurance Corporation has issued a proposed regulation intended to address an emerging issue in international banking: how to grant non-US branch deposits equal treatment with US deposits in the event of the bank’s insolvency. Below are both big-picture and technical issues that need to be addressed in order to make the proposal effective.

The proposed regulation would effectively grant deposit status at non-US branches of US insured banks to deposits booked there for purposes of the depositor preference provisions of Federal law. [1] Its purpose is to provide the benefits of depositor preference status to deposits in branches in other countries. Depositor preference simply means that, in the liquidation of the bank, deposits will be paid ahead of non-deposit unsecured creditors, thereby increasing significantly the likelihood of full or almost-full repayment. This issue has been spotlighted by the United Kingdom, which has proposed to require that UK branches of foreign banks be entitled to depositor preference under their home country insolvency rules or provide clear disclosure of its absence to their depositors. This requirement, if implemented, might create an incentive for US banks to take such steps as making their US offices liable for repayment of such deposits; these would be so-called “dual-office” deposits, in which both a US and a non-US office would be liable for repayment.

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Responding to Objections to Shining Light on Corporate Political Spending (4): The Claim that Such Disclosure Would Give a Political Advantage to Unions

Posted by Lucian Bebchuk, Harvard Law School, and Robert J. Jackson, Jr., Columbia Law School, on
Thursday, April 25, 2013
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Lucian Bebchuk is Professor of Law, Economics, and Finance at Harvard Law School. Robert J. Jackson, Jr. is Associate Professor of Law and Milton Handler Fellow at Columbia Law School. Bebchuk and Jackson served as co-chairs of the Committee on Disclosure of Corporate Political Spending, which filed a rulemaking petition requesting that the SEC require all public companies to disclose their political spending, discussed on the Forum here. Bebchuk and Jackson are also co-authors of Corporate Political Speech: Who Decides? and Shining Light on Corporate Political Spending, coming out this month in the Georgetown Law Journal. This post is the fourth in a series of posts, based on the Shining Light article, in which Bebchuk and Jackson respond to objections to an SEC rule requiring disclosure of corporate political spending; the full series of posts is available here.

In our first three posts in this series (available here, here and here), we examined three objections raised by opponents of mandating disclosure of political spending and explained why these objections provide no basis for opposing such rules. In this post, we focus on a fourth objection that opponents of these rules have raised: the claim that requiring disclosure of corporate political spending would create an important imbalance in the information that is provided to investors and voters about two of the most significant sources of spending on politics: corporations and labor unions.

Several opponents of the petition have argued that disclosure of corporate political spending would convey an important political advantage to labor unions—organizations that, opponents argue, may also engage in undisclosed spending on politics. For example, Senator John McCain has argued that disclosure of corporate spending on politics “forces some entities to inform the public about the origins of their financial support, while allowing others—most notably, those affiliated with organized labor—to fly below the radar.”

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BDCs and 1940 Act Funds

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, April 25, 2013
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The following post comes to us from Lawton M. Camp, partner at Allen & Overy LLP specializing in structured finance and securitization, and is based on an Allen & Overy memorandum by Mr. Camp and Marc Ponchione.

Goldman Sachs’ recent filing with the Securities and Exchange Commission (SEC) to launch a “business development company,” or BDC, should be of interest to financial services companies, particularly banking institutions structuring and restructuring their operations and product offerings to comply with the Volcker Rule’s prohibitions on investing in and sponsoring “covered funds.” A BDC is a closed-end investment company that elects to be regulated under the Investment Company Act of 1940 (1940 Act), and thus, like a 1940 Act closed-end fund or mutual fund, is not by definition a “covered fund,” which is defined generally as a vehicle that relies on the exception from the definition of investment company found in Section 3(c)(1) or Section 3(c)(7) of the 1940 Act. Below we discuss certain aspects of the operation and regulation of a BDC under the 1940 Act.

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“Bold” Enforcement Envisioned following the Confirmation of Mary Jo White As SEC Chair

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, April 25, 2013
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The following post comes to us from Michael D. Trager, senior partner at Arnold & Porter LLP and chair of the firm’s Securities Enforcement Practice. This post is based on a Arnold & Porter memorandum; the full text, including footnotes, is available here. An update to this memo is available here.

The Securities and Exchange Commission is undergoing a period of transition due to a series of recent changes in top leadership positions. On April 8, 2013, the U.S. Senate confirmed the nomination of Mary Jo White as the new Chairman of the SEC, and, on April 10, she was officially sworn in as the 31st Commission Chairman. White succeeds Elisse Walter, who replaced Mary Schapiro as Chairman in December 2012. Moreover, in February 2013, Enforcement Division Director Robert Khuzami stepped down, and Walter appointed George Canellos as Acting Director of the Enforcement Division; it is anticipated that White will name the permanent Enforcement Division Director shortly.

This post discusses recent public statements by top enforcement officials regarding the SEC’s enforcement priorities, trends, and strategies. In particular, this post discusses White’s confirmation hearing before the Senate Banking Committee on March 12, 2013, in which she outlined her vision for the SEC and promised continued aggressive enforcement. This post also discusses statements by top officials at the annual SEC Speaks conference on February 22 and 23, 2013, which reviewed recent enforcement efforts and previewed the Enforcement Division’s priorities in the year ahead.

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Regulation of Cross-Border OTC Derivatives Activities: Finding the Middle Ground

Posted by Elisse Walter, Commissioner, U.S. Securities and Exchange Commission, on
Wednesday, April 24, 2013
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Elisse B. Walter is a Commissioner at the U.S. Securities and Exchange Commission and was the Chairman of the SEC from December 2012 to April 2013. This post is based on Commissioner Walter’s recent remarks at the American Bar Association Spring meeting, available here. The views expressed in this post are those of Commissioner Walter and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

Today at the SEC and in government agencies around the world, regulators are shaping the rules that will govern the way over-the-counter derivatives are transacted. It’s a crucial task given the magnitude and importance of this market to the international financial system.

In the process, all of us are grappling with the fact that these transactions rarely respect national boundaries. They are complex transactions that routinely cross borders, and are potentially subject to multiple sets of rules.

To ensure our regimes work effectively, we need to have a common sense, flexible approach to the cross-border regulation of derivatives.

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A Call on U.S. Independent Directors to Develop Shareholder Engagement Strategies

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, April 24, 2013
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The following post comes to us from Deborah Gilshan, Corporate Governance Counsel at RPMI Railpen Investments, and Catherine Jackson, Corporate Governance Advisor at PGGM Investments.

We are witnessing a change in sentiment about independent director involvement in engagement meetings with shareholders. These interactions help to:

  • Establish respect and understanding;
  • Create a culture of no surprises; and
  • Assess the quality and independence of directors by permitting shareholders the opportunity to learn how key board functions are managed and overseen.

To facilitate these interactions, we call on the independent directors of U.S. companies to develop suitable strategies that address their responsibility to communicate with shareholders.

Companies with significant governance concerns are increasingly recognizing the value of their independent directors engaging with shareholders. We are encouraged that some independent directors are actively seeking input from their shareholders to pre-emptively manage situations, while others are interested in understanding shareholder views on certain matters. However, such practices are by no means universal, with communication often occurring unilaterally through press statements and proxy disclosures rather than in face-to-face exchanges with shareholders. We advocate for independent director meetings with shareholders to become a routine part of a board’s approach to outreach with its shareholders, rather than only in exceptional circumstances or in times of crisis.

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CEO Contract Design: How Do Strong Principals Do It?

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, April 24, 2013
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The following post comes to us from Henrik Cronqvist, Associate Professor of Finance at Claremont McKenna College and Rüdiger Fahlenbrach, Associate Professor of Finance at the Ecole Polytechnique Federale de Lausanne (EPFL) and affiliated with the Swiss Finance Institute.

In our paper, CEO Contract Design: How Do Strong Principals Do It?, forthcoming in the Journal of Financial Economics, we contribute a new perspective on executive compensation research by studying changes to CEO employment contracts implemented by some of the most sophisticated and financially savvy principals in U.S. capital markets: private equity sponsors. If the changes in a firm’s governance structure following a leveraged buyout (LBO) allow for arm’s-length bargaining between private equity (PE) sponsors, as ‘‘strong principals,’’ and the CEOs of the portfolio companies as their agents, we may observe changes to contract features of importance to the private equity sponsors.

Our objective in this paper is to answer three questions. First, do the strong principals redesign CEO contracts? If they do, which contract features do they change? We examine a comprehensive set of features of CEO contracts in addition to cash pay, such as perquisites, equity incentives, vesting conditions, and severance pay. Second, how do the CEO contracts designed by PE sponsors square with contracting theories? Finally, do the CEO contracts we study avoid some of the most criticized compensation practices in U.S. public firms? Regulators and shareholder interest groups should be interested in whether their proposals differ markedly from contracts where a shareholder with significant ownership and financial expertise bargains with a CEO.

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Institutional Investors: Power and Responsibility

Posted by Luis A. Aguilar, Commissioner, U.S. Securities and Exchange Commission, on
Tuesday, April 23, 2013
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Editor’s Note: Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s remarks at a recent CEAR Workshop in Atlanta, GA; the full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

I am particularly pleased to be at a conference that focuses on the role of institutional investors and their impact on corporate control, market liquidity, and systemic risk. The SEC has a great deal of interest in these areas and I hope that you will provide us with any observations that can help inform the SEC’s understanding.

Role Played by Institutional Investors

The topic of your conference recognizes the important role played by institutional investors and the great influence they exert in our capital markets. The role and influence of institutional investors has grown over time. For example, the proportion of U.S. public equities managed by institutions has risen steadily over the past six decades, from about 7 or 8% of market capitalization in 1950, to about 67 % in 2010. The shift has come as more American families participate in the capital markets through pooled-investment vehicles, such as mutual funds and exchange traded funds (ETFs).

Institutional investor ownership is an even more significant factor in the largest corporations: In 2009, institutional investors owned in the aggregate 73% of the outstanding equity in the 1,000 largest U.S. corporations.

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Dismantling Large Bank Holding Companies

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, April 23, 2013
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The following post comes to us from Tamar Frankel, Professor of Law at Boston University Law School.

Mammoth bank holding companies (BHCs) have contributed to the 2008 crisis. Their “contribution” may stem from their structure.

Most BHCs are not banks but “financial malls,” of “shops” serving as brokers-dealers, underwriters, advisers (to mutual funds, trust funds, and wealthy individuals), banks proper, insurance, lending, “securitizers,” guarantors and traders for the BHCs’ own account, and more. A BHC owns the mall’s financial shops, collects their revenues, and raises funds from investors. Its management finances the shops and rewards shop managers. Managing the variety of shops that closely reflect the entire financial system is difficult. Not surprisingly, BHCs periodically produce enormous profits and bear enormous losses.

Compare BHCs structure to other malls: In business malls, mall owners serve all the shops’ needs. But these shops (pharmacies or restaurants) have different owners, customers, and regulators. Mutual fund “malls” are serviced by one adviser but owned by investors. Displeased investors can decimate their funds by redeeming their shares. Under the structure of Vanguard, the largest in the United States today, the shops—the funds (their investors) own the mall, and pay for its services. As to performance, each fund “sits on its own bottom,” judged by its shareholders, rather than by a management or a holding company’s shareholders. Yet, a fund’s failure does not shake the economy and taxpayers do not bear the cost.

The BHC structural model raises serious disadvantages for their investors, and for the financial system, against which current regulation does not effectively protect:

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