Yearly Archives: 2013

Important Questions about Activist Hedge Funds

Posted by Martin Lipton, Wachtell, Lipton, Rosen & Katz, on
Saturday, March 9, 2013
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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, Adam O. Emmerich, David C. Karp, Mark Gordon, and Sabastian V. Niles.

In what can only be considered a form of extortion, activist hedge funds are preying on American corporations to create short-term increases in the market price of their stock at the expense of long-term value. Prominent academics are serving the narrow interests of activist hedge funds by arguing that the activists perform an important service by uncovering “under-valued” or “under-managed” corporations and marshaling the voting power of institutional investors to force sale, liquidation or restructuring transactions to gain a pop in the price of their stock. The activist hedge fund leads the attack, and most institutional investors make little or no effort to determine long-term value (and how much of it is being destroyed). Nor do the activist hedge funds and institutional investors (much less, their academic cheerleaders) make any effort to take into account the consequences to employees and communities of the corporations that are attacked. Nor do they pay any attention to the impact of the short-termism that their raids impose and enforce on all corporations, and the concomitant adverse impact on capital investment, research and development, innovation and the economy and society as a whole.

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EU Reaches Deal on Proposed Ratio Cap on Bank Bonuses

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, March 8, 2013
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This post comes to us from John J. Cannon, partner in the Executive Compensation and Employee Benefits Group at Shearman & Sterling LLP.

On 27 February 2013 the European Union (“EU”) reached a provisional deal on imposing a cap on the variable remuneration that can be paid by financial institutions in the EU. If, as expected, this provisional deal is formally approved by the EU Parliament and Council later this year, far-reaching changes will need to be implemented in the remuneration structures of many EU-headquartered banks and non-EU headquartered banks operating in the EU.

The Key Proposals

As part of negotiations on the new capital requirements under the Basel III rules, a provisional deal has been reached on proposed ratio caps on variable pay. The key proposals are: [1]

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Optimal Corporate Governance in the Presence of an Activist Investor

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, March 8, 2013
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The following post comes to us from Jonathan Cohn of the Department of Finance at the University of Texas at Austin and Uday Rajan of the Department of Finance at the University of Michigan.

In our paper, Optimal Corporate Governance in the Presence of an Activist Investor, forthcoming in the Review of Financial Studies, we provide a model of governance in which a board arbitrates between an activist investor and a manager facing reputational concerns. Shareholder activism to force policy changes at publicly-traded firms represents an increasingly important dimension of the market for corporate control. While activist investors represent a source of corporate governance that is external to a firm’s power structure, they differ dramatically from the corporate raiders that are the focus of earlier theories of external governance. In most cases, activist investors accumulate relatively small stakes and so cannot exert direct control. Rather, they must rely on persuasion and the firm’s internal governance mechanisms to implement changes. As Brav et al. (2008) show, activist hedge funds are often successful in influencing managers and boards, and their efforts have a substantial impact on firm value.

How does the presence of such an external governance force affect internal governance policy? To address this question, we analyze a model in which a board, recognizing that an activist shareholder may exert discipline on a manager, chooses an appropriate level of internal governance. To our knowledge, this is the first theoretical article to consider the interaction between an activist, the board, and a manager. We argue that the possibility of disputes between an activist and management creates a natural but novel role for the board of directors that has not been considered previously: It functions as an arbitrator between different stakeholders who wish to take the firm in different directions.

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Materiality and Class Certification in Fraud-on-the-Market Cases

Posted by Brad S. Karp, Paul, Weiss, Rifkind, Wharton & Garrison LLP, on
Thursday, March 7, 2013
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Brad Karp is chairman and partner at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul Weiss client memorandum and elaborates on a previous post we featured regarding Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, available here.

In Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, No. 11-1085, 2013 WL 691001 (Feb. 27, 2013), the Supreme Court of the United States decided a significant issue concerning the requirements for class certification in actions based on alleged misrepresentations in violation of the federal securities laws. Under Amgen, a plaintiff in such an action is not required to prove the materiality of the alleged misrepresentation in order to obtain class certification. The Amgen decision will make it at least marginally easier for plaintiffs to obtain class certification in some Circuits.

Amgen is likely to be influential in ways that go well beyond its immediate holding. For example, the various opinions in Amgen debate the continuing vitality of the Supreme Court’s decision in Basic Inc. v. Levinson, 485 U.S. 224 (1988), which established the fundamental structure enabling claims under the federal securities laws to be litigated as class actions. These and other implications of the decision are discussed below. Readers not requiring a summary of the framework established in Basic may wish to go directly to section 2.

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Complexities of Capital Markets Regulation

Posted by Daniel M. Gallagher, Commissioner, U.S. Securities and Exchange Commission, on
Thursday, March 7, 2013
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Daniel M. Gallagher is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Gallagher’s keynote speech at the 7th Gulf Cooperation Council Regulators’ Summit in Doha, Qatar; the full speech, 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 often remark that we are blessed by our geography. And there is no doubt that Qataris feel the same about this incredibly unique and beautiful country. In the United States during the post World War II era, our geographical position and natural resources helped our economy develop while others experienced severe disruptions, particularly in Europe. That promoted the development of our capital markets to the great benefit of our citizens, as well as investors foreign and domestic and our partners-in-trade around the world.

It is certainly true that we have suffered our share of economic and financial crises, most recently the crisis that erupted in 2008. Even so, our free market economy and robust capital markets have conferred an enviable prosperity on our people over many years. Indeed, notwithstanding financial crises large and small, it is fair to point out that few in America can remember a time when the United States did not have strong and competitive capital markets.

The risk, however, is that the very resilience of our capital markets has, over time, fostered a latent complacency — a tendency to think strong and competitive markets are, somehow, ours by right — that we are entitled to them when, in reality, we must constantly act — and sometimes decide 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 and competitive. That’s not just good for U.S. investors, I submit, but equally good for others — for all of you. And, of course, rising global markets are good for the United States.

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Initial 2013 Annual Meeting Results: Six Board Declassification Proposals Passed with Average Support of 79%

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Wednesday, March 6, 2013
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Editor’s Note: Professor Lucian Bebchuk is the Director of the Shareholder Rights Project (SRP), Scott Hirst is the SRP’s Associate Director, and June Rhee is Counsel at the SRP. The SRP, a clinical program operating at Harvard Law School, works on behalf of public pension funds and charitable organizations seeking to improve corporate governance at publicly traded companies, as well as on research and policy projects related to corporate governance. Any views expressed and positions taken by the SRP and its representatives should be attributed solely to the SRP and not to Harvard Law School or Harvard University. The work of the SRP has been discussed in other posts on the Forum available here.

Although the 2013 proxy season is still in its early stages, board declassification proposals submitted by the Shareholder Rights Project (SRP) on behalf of SRP-represented investors have already gone to a vote at the 2013 annual meetings of six S&P 500 and Fortune 500 companies, and these proposals all passed by substantial majorities, receiving average support of 79% of votes cast.

This result continues the strong record of success for SRP-represented investors in 2012, and reflects the on-going strong support for board declassification among institutional investors. The table below provides information concerning these six precatory declassification proposals, all submitted on behalf of the Massachusetts Pension Reserves Investment Management Board (PRIM).

DECLASSIFICATION PROPOSALS GOING TO A VOTE SO FAR IN 2013

Company % of Votes
Cast in Favor
Air Products and Chemicals, Inc. (APD) 80.2%
Ashland Inc. (ASH) 82.6%
Costco Wholesale Corporation (COST) 71.9%
Jacobs Engineering Group Inc. (JEC) 82.2%
Rockwell Collins, Inc. (COL) 83.0%
Varian Medical Systems, Inc. (VAR) 74.8%
Average: 79.1%

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Unbundling Rules and Say-on-Pay Decisions in Apple Shareholder Case

Posted by James Morphy, Sullivan & Cromwell LLP, on
Wednesday, March 6, 2013
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James C. Morphy is a partner at Sullivan & Cromwell LLP specializing in mergers & acquisitions and corporate governance. The following post is based on a Sullivan & Cromwell publication.

On February 22, 2013, the United States District Court for the Southern District of New York enjoined Apple, Inc. from proceeding with a planned vote at its annual shareholders’ meeting on amendments to certain provisions of its articles of incorporation on the grounds that the proposed amendments, which were presented as a single matter to be voted upon, likely violated SEC rules prohibiting the “bundling” of separate matters into a single vote.

In the same opinion, the court rejected a shareholder petition to enjoin Apple’s “say-on-pay” vote. In that regard, the shareholder made similar arguments as those in complaints received by numerous companies in recent months – namely, that the Compensation Discussion and Analysis section was not compliant with SEC rules because it gave insufficient detail on the compensation committee’s decision-making process and the information the committee had. The court disagreed, holding that Apple’s disclosure was “plainly sufficient under SEC rules.”

The unbundling decision serves as a reminder that companies preparing their proxy statements for upcoming annual meetings should ensure that all material, separate matters are presented for separate votes. The mere fact that multiple matters are included in a single charter amendment, or that the matters are all broadly “shareholder-friendly,” is not, based on the Apple decision, sufficient to avoid a violation of the unbundling rules.

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Comparability, Capital Market Benefits, and the Voluntary Adoption of IFRS

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, March 6, 2013
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The following post comes to us from Mary Barth, Professor of Accounting at Stanford University; Wayne Landsman, Professor of Accounting at the University of North Carolina; Mark Lang, Professor of Accounting at the University of North Carolina; and Christopher Williams of the Department of Accounting at the University of Michigan.

In our paper, Effects on Comparability and Capital Market Benefits of Voluntary Adoption of IFRS by US Firms: Insights from Voluntary Adoption of IFRS by Non-US Firms, which was recently made publicly available on SSRN, we examine whether voluntary adoption of IFRS is associated with an increase in comparability of accounting amounts and capital market benefits after the firms adopt IFRS. Our evidence is based on samples of non-US firms that voluntarily adopt IFRS matched with firms of similar size in their country and industry that either adopted IFRS before them or do not adopt IFRS.

We find that after firms voluntarily adopt IFRS, their accounting amounts become more comparable to those of firms that adopted IFRS before them and less comparable to those of firms that do not adopt IFRS. We also find that adopting firms generally exhibit an increase in capital market benefits—liquidity, share turnover, and firm-specific information—relative to both adopted and non-adopting firms. However, there is little evidence of capital market consequences for adopted firms and little evidence that non-adopting firms suffer a decrease in capital market benefits.

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The “Hindsight” Principle and Clients of Insolvent UK Brokers

Posted by Barnabas Reynolds, Shearman & Sterling, on
Tuesday, March 5, 2013
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Barnabas Reynolds is head of the global Financial Institutions Advisory & Financial Regulatory Group at Shearman & Sterling LLP. This post is based on a Shearman & Sterling client publication.

The High Court in London has held that clients of insolvent UK brokers are entitled to a claim based on the value of their open positions as at the date of entry into administration or liquidation, rather than based on the value actually realised when those positions are closed. The “hindsight” principle – that where assets are later actually valued, actual values should be used – is not applicable.

Background

Under the client money and client asset rules contained in the CASS 7 and 7A sourcebooks of the UK Financial Services Authority (the “FSA”) Handbook (the “client money rules”), brokers are required to segregate money received from or held for their clients and will hold such funds pursuant to a statutory trust. In the event of the broker entering administration or liquidation, client money is segregated from the broker’s property and is distributed to clients on a pari passu basis (meaning “pro rata”).

The client money rules have been the subject of protracted litigation and judicial criticism in various cases due to their lack of clarity and even drafting errors. A number of issues regarding the client money rules were resolved by the UK Supreme Court in February 2012 in the litigation arising out of the Lehman insolvency, and have been discussed in a previous client publication. [1] The client money rules have also been amended in various ways and are currently subject to a consultation process for more wholesale amendment. [2]

On 31 October 2011, investment broker MF Global UK Limited became the first investment company to enter the special administration regime under the Investment Bank Special Administration Regulations 2011. It held client money as well as many open derivative positions for clients.

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Limited Partner Performance and Maturing of the Private Equity Industry

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, March 5, 2013
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The following post comes to us from Berk Sensoy, Assistant Professor of Finance at the Ohio State University; Yingdi Wang, Assistant Professor of Finance at the California State University at Fullerton; and Michael Weisbach, Professor of Finance at the Ohio State University.

Since the modification of the “Prudent Man” rule in 1978 that allowed institutional investors to allocate part of their portfolios to alternative assets, the private equity industry has changed substantially. In 1980, the largest fund raised was the Golder-Thoma $60 million dollar fund that invested in many different kinds of deals, including both venture capital and buyouts. At the time, institutional investors were somewhat skeptical of the industry, GPs, LPs and portfolio firms were experimenting with different contractual structures, and indeed “private equity” itself was not an accepted term. By the time of the 2008 Financial Crisis, individual funds of over $20 billion were being raised, funds became specialized in particular types of investments so that “renewable energy” or “infrastructure” funds were commonplace, contracts have become standardized, and private equity has become an accepted part of the financial world in which most major business schools teach courses, and is even a topic for debate in presidential campaigns.

It is natural that such maturing of an industry can lead to changes in the fundamental relationships between participants. In the private equity industry, the major participants are the limited partners (LPs), the general partners (GPs), and the portfolio companies. In the paper, Limited Partner Performance and the Maturing of the Private Equity Industry, which was recently made publicly available on SSRN, my co-authors (Berk Sensoy and Yingdi Wang) and I explore the relationship between limited partners and general partners by focusing on access to funds, and the way in which it has changed over recent years. An overarching hypothesis is that the fundamental changes brought on by the maturing of the private equity industry have changed the nature of relationship between limited partners and general partners in private equity.

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