Yearly Archives: 2013

Out of the Shadows and Into the Light

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, January 29, 2013
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The following post comes to us from Jeremy Jennings-Mares, partner in the Capital Markets practice at Morrison & Foerster LLP, and is based on a Morrison & Foerster bulletin by Mr. Jennings-Mares, Peter Green, and Lewis Lee.

For the last four years, regulators and law makers have been focusing extraordinary efforts on ensuring that financial regulation is adequate to protect the financial system from risks emanating from the banking sector. However, it is only more recently that policy makers have turned their attention towards possible systemic risk related to entities which carry out similar functions to the banking sector or to which the banking sector is otherwise exposed. Such entities have, for convenience, been grouped under the heading of “shadow banks”, although no precise definition or description of shadow banking has yet been agreed upon by policy makers.

At their November 2010 Seoul Summit, the leaders of the G20 nations requested that the Financial Stability Board (FSB) develop recommendations to strengthen the oversight and regulation of the shadow banking system in collaboration with other international standard setting bodies, and in response to such request, the FSB formed a task force with the following objectives:

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Assigning Value to Long-Term Incentive Pay

Posted by Joseph E. Bachelder III, McCarter & English, LLP, on
Monday, January 28, 2013
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Joseph Bachelder is special counsel in the Tax, Employee Benefits & Private Clients practice group at McCarter & English, LLP. This post is based on an article by Mr. Bachelder, with assistance from Andy Tsang, which first appeared in the New York Law Journal.

“Then you should say what you mean,” the March Hare went on.

“I do,” Alice hastily replied; “at least—at least I mean what I say—that’s the same thing, you know.”

“Not the same thing a bit!” said the Hatter. “You might just as well say that ‘I see what I eat’ is the same thing as ‘I eat what I see’!”

Alice in Wonderland, Lewis Carroll (1865)

The Preamble to SEC Disclosure Regulations (2006) [1] states: “We believe that plain English principles should apply to the disclosure requirements that we are adopting, so disclosure provided in response to those requirements is easier to read and understand. Clearer, more concise presentation of executive and director compensation…can facilitate more informed investing and voting decisions in the face of complex information about these important areas.”

To which the Mad Hatter might have responded: “You can assume plain English conveys clear thinking, but what happens if plain English is not fed by clear thinking?”

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Selected Issues for Boards of Directors in 2013

Posted by Victor I. Lewkow, Cleary Gottlieb Steen & Hamilton LLP, on
Monday, January 28, 2013
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Victor Lewkow is a partner at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum by Mr. Lewkow, Alan Beller, Mitchell Lowenthal, Janet Fisher, Arthur Kohn, David Leinwand, and Ethan Klingsberg.

In the years since the financial reporting scandals and the Sarbanes-Oxley Act of 2002, and in particular following the financial crisis and the Dodd-Frank Act of 2010, boards of directors have faced greater burdens and more intense scrutiny of their activities and performance. One manifestation of this has been pressure to change the role of directors from one of partnership with and oversight of management to one of an almost quasi-governmental watchdog directly responsible for monitoring management’s performance, including its compliance with increasingly complex and burdensome regulation. In addition, activist investors continue to publicly push some boards to pursue strategies focused on short-term returns, even in instances where those strategies are inconsistent with the directors’ preferred, sustainable long-term strategies for the corporation.

In recent years, we have advised that directors regularly work with their advisors to monitor and adapt to the continually changing landscape. Among other things, we have suggested more frequent, well-structured engagement with shareholders, a focus on the ability to communicate the corporation’s and board’s policies in a way that is understandable and convincing to the corporation’s constituencies, and that directors prepare to respond to increasing external pressures in a manner that both thoughtfully takes those pressures into account and fully reflects the director’s carefully considered view of the long-term interests of the corporation.

In addition to these general points, we also have seen developing during 2012 a series of additional specific issues, discussed below, on which we believe boards of directors and corporations should focus in 2013.

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The Evolution of Corporate Governance in Brazil

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, January 28, 2013
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The following post comes to us from Bernard Black, the Nicholas D. Chabraja Professor at Northwestern University School of Law and Kellogg School of Management, and Antonio Gledson de Carvalho, Associate Professor at Fundacao Getulio Vargas School of Business at Sao Paulo, and Joelson Oliveira Sampaio at Fundacao Getulio Vargas School of Business at Sao Paulo.

In the past decades the Brazilian economy has undergone major changes such as macroeconomic stability; achievement of investment grade status for the debt of the government and many individual firms; strong economic growth; and development of pension funds, which became major investors in public company shares. Significant changes were also observed in the stock market. Through the early 2000s, Brazil was seen as having relatively weak corporate governance. Examples of expropriation of minority shareholders by controlling shareholders were common.

In 2000, in response to concern about weak protection for minority shareholders (including extensive use of non-voting shares, few outside directors, and low levels of disclosure), the São Paulo Stock Exchange (BM&FBovespa) created three high-governance markets (Novo Mercado, Level I and Level II). This contributed to a surge in initial public offerings, which had been nearly nonexistent until 2004; a leveling off in the number of listed companies, which had been shrinking; and sharply rising trading volume and liquidity. Most new listings were at one of the premium listing levels; some older companies also migrated their listings to a higher level. In spite of these major changes in the economy and the stock market, little is known about how corporate governance standards have been changing. This article, The Evolution of Corporate Governance in Brazil, aims at filling this gap by providing a picture of the evolution of corporate governance practices in Brazil.

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FSA Calendar Year-End Update 2012

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Sunday, January 27, 2013
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The following post comes to us from Paul Hinton, Vice President at NERA Economic Consulting, and is based on a NERA publication by Mr. Hinton, Robert Patton, and Zachary Slabotsky; the full document, including footnotes, is available here.

Fines imposed by the Financial Services Authority (FSA) since 1 January 2012 (through 20 December) have totalled £310 million, more than four times the total for 2011 (see Figure 1 below). This increase is due to a handful of very large fines, including the £160 million fine against UBS for LIBOR manipulation announced 19 December, which is the largest-ever FSA fine by a substantial margin.

The number of fines assessed against firms, 25, was in line with last year. In contrast, the number of fines against individuals fell to its lowest level since 2009, and the aggregate fine amount imposed on individuals fell slightly compared to 2011.

The dramatic increase in aggregate fines is the result of a few headline-grabbing penalties against banks, notably those against UBS and Barclays for manipulation of LIBOR and EURIBOR, and against UBS for failing to prevent unauthorised trading by a rogue trader, Kweku Adoboli. Those three fines alone totalled nearly £250 million. The size of fines against banks, of which there were nine in 2012 as compared to seven in 2011, largely explains the £244 million jump in the annual totals.

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EU Commission Proposes Action Plan for Corporate Governance

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Saturday, January 26, 2013
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The following post comes to us from James R. Modrall, partner focusing on EU and international competition law at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum; the full publication, including footnotes, is available here.

On December 12, 2012, the European Commission published an Action Plan with initiatives it intends to undertake in 2013 in the fields of EU company law and corporate governance. These initiatives are primarily inspired by the responses to the Commission’s 2011 Green Paper on the EU corporate governance framework and an on-line consultation on the future of European company law. They are aimed at enhancing transparency, engaging shareholders and simplifying cross-border operations of EU companies. The Commission further plans to codify a number of major EU company law directives.

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A “Sea Change” in Public Pension Reporting on the Horizon

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, January 25, 2013
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The following post comes to us from Michael A. Moran, Pension Strategist at Goldman Sachs Asset Management. This post is based on a Goldman Sachs white paper by Mr. Moran.

Executive Summary

Recently issued rules by the Governmental Accounting Standards Board (GASB) will notably change the way state and local governments account for and report the results of their defined benefit pension plans. Some plans may see their reported funded percentages fall under the new requirements. A plan’s funded status will now be reflected on the balance sheet, increasing transparency as well as the focus on measures that plan sponsors are taking to address these shortfalls. Funded status and pension expense measures are also likely to be more volatile under the revised reporting standards.

While the new GASB rules change some important aspects of public DB plan reporting, they do not change others. In particular, they neither mandate use of a lower discount rate for calculating liabilities nor higher contribution requirements. These are changes to accounting and financial reporting, not economics. Nonetheless, they do represent a notable change to the calculation and reporting of various pension-related metrics.

Some public DB plan sponsors are already facing significant challenges, such as relatively low funded levels. In addition, given budgetary challenges, some state and local governments do not have the flexibility to increase contributions at this time. All of this is occurring in an environment where long-term expected returns across a wide variety of asset classes have been falling. The GASB changes may add yet another layer of stress, if not complexity, for some public plan sponsors.

This paper reviews the following aspects of the GASB changes:

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Are Mutual Funds Active Voters?

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, January 25, 2013
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The following post comes to us from Peter Iliev and Michelle Lowry, both of the Department of Finance at Penn State University.

In our paper, Are Mutual Funds Active Voters?, which was recently made publicly available on SSRN, we document that mutual funds vary significantly in how they fulfill their fiduciary duty to vote their shares in shareholders’ interests. Approximately 25% of mutual funds vote with ISS on nearly all company agenda items throughout our five-year sample period. However, many other mutual funds disagree frequently with ISS, particularly on contentious votes. We find that certain types of funds are more likely to find it optimal to incur the costs of evaluating the necessary information to independently assess the items up for vote. For example, large funds and funds from top 5 families can spread the costs over a wider asset base, and low turnover funds are more likely to own the stocks long enough to realize the valuation effects of the vote outcome and any consequent changes in company governance. We would thus expect such funds to be more likely to actively vote. A summary measure of fund activism, which is based on six fund characteristics, highlights the extent to which variation in funds’ costs and benefits of actively voting translates into dramatically different voting patterns. Across a sample of contentious compensation and governance votes, we find that passive funds follow ISS in 86% of the compensation and 77% of the governance votes, compared to analogous rates of only 15% and 19% among actively voting funds. Similarly, across a sample of contentious director votes, passive funds are approximately three times more likely than active funds to follow ISS.

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The JP Morgan “Whale” Report and the Ghosts of the Financial Crisis

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Thursday, January 24, 2013
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Editor’s Note: Ben W. Heineman, Jr. is a former GE senior vice president for law and public affairs and a senior fellow at Harvard University’s schools of law and government. This post is based on an article that appeared in the Harvard Business Review online.

The apparition of 2008 returns once more. Two recently released JP Morgan Chase (JPM) reports on the causes of the “London Whale” trading losses raise important questions about whether financial service firms can exorcise the spectral issues which were so central to the financial crisis. They read as if JPM and a key headquarters unit — the Chief Investment Office — had not learned a single lesson from the meltdown four years ago. And unfortunately, they suggest that, in our huge, complex financial institutions, major failures of organizational discipline and major losses are likely to recur, despite greater attention to risk management.

These reports — one from a company task force and a second from a review committee of the board — were overshadowed by two items announced the same day: the related news that the bank board had slashed CEO Jamie Dimon’s annual compensation in half — from $23 million in 2011 to $11.5 million in 2012 — because of his “Whale-related” failures, and that JPM had posted a record 2012 net income of $21.3 billion.

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Federal Reserve Updates Consolidated Supervision Framework for Large Financial Institutions

Posted by H. Rodgin Cohen, Sullivan & Cromwell LLP, on
Thursday, January 24, 2013
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H. Rodgin Cohen is a partner and senior chairman of Sullivan & Cromwell LLP focusing on acquisition, corporate governance, regulatory and securities law matters. This post is based on a Sullivan & Cromwell LLP publication by Aaron Nagano.

Summary

On December 17, 2012, the staff of the Federal Reserve issued a Supervision and Regulation (“SR”) letter describing the Federal Reserve’s new framework for consolidated supervision of large financial institutions. SR letters address significant policy and procedural matters related to the Federal Reserve’s supervisory responsibilities.

Under the new framework, the Federal Reserve’s primary supervisory objectives for large financial institutions will be (1) to enhance resiliency of an institution to lower the probability of its failure or its becoming unable to serve as a financial intermediary, and (2) to reduce the impact on the financial system and the broader economy of an institution’s failure or material weakness. These objectives are meant to conform to key provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, such as enhanced prudential standards for large financial institutions. Although the Federal Reserve has not previously stated these objectives as its primary supervisory objectives, and the new framework formally integrates areas such as corporate governance and compensation that Federal Reserve staff has been focused on since the financial crisis, changes in specific supervisory expectations are limited. Changes include greater emphasis on recovery planning in the case of financial or operational weakness, and on orderly resolution planning, as required by the Dodd-Frank Act. The Federal Reserve will also engage in greater “macroprudential” supervision to detect systemic risks.

The new framework applies to the largest and most complex financial institutions subject to consolidated Federal Reserve supervision, including nonbank financial companies designated by the Financial Stability Oversight Council for supervision by the Federal Reserve; other domestic bank and savings and loan holding companies with consolidated assets of $50 billion or more; and other foreign banking organizations with combined assets of U.S. operations of $50 billion or more.

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