Monthly Archives: February 2014

SEC Investigations and Enforcement Related to Financial Reporting and Accounting

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Sunday, February 16, 2014
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The following post comes to us from Randall J. Fons, partner and co-chair of the Securities Litigation, Enforcement, and White-Collar Defense Group and the global FCPA and Anti-Corruption Task Force at Morrison & Foerster LLP, and is based on a Morrison & Foerster publication by Mr. Fons.

“One of our goals is to see that the SEC’s enforcement program is—and is perceived to be—everywhere, pursuing all types of violations of our federal securities laws, big and small.”
— Mary Jo White, Chair of the SEC, October 9, 2013

“In the end, our view is that we will not know whether there has been an overall reduction in accounting fraud until we devote the resources to find out, which is what we are doing.”
— Andrew Ceresney, Co-Director of the SEC Division of Enforcement, September 19, 2013

“The SEC is ‘Bringin’ Sexy Back’ to Accounting Investigations”
— New York Times, June 3, 2013

Much has changed since the collapse of Enron in 2001 and the ensuing avalanche of financial fraud cases brought by the SEC. For example, Sarbanes-Oxley raised auditing standards, imposed certification requirements on public company officers and required enhanced internal controls for public companies. The Public Company Accounting Oversight Board (PCAOB) was formed “to oversee the audits of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, accurate and independent audit
reports.” [1] In pursuit of that goal, the PCAOB has conducted hundreds of audit firm inspections, adopted numerous auditing standards and brought dozens of enforcement actions against auditors for violating PCAOB rules and auditing standards.

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Governance Priorities for 2014

Posted by Holly J. Gregory, Sidley Austin LLP, on
Saturday, February 15, 2014
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Holly J. Gregory is a partner and co-global coordinator of the Corporate Governance and Executive Compensation group at Sidley Austin LLP. This post is based on an article that originally appeared in Practical Law The Journal. The views expressed in the post are those of Ms. Gregory and do not reflect the views of Sidley Austin LLP or its clients.

As the fallout from the financial crisis recedes and both institutional investors and corporate boards gain experience with expanded corporate governance regulation, the coming year holds some promise of decreased tensions in board-shareholder relations. With governance settling in to a “new normal,” influential shareholders and boards should refocus their attention on the fundamental aspects of their roles as they relate to the creation of long-term value.

Institutional investors and their beneficiaries, and society at large, have a decided interest in the long-term health of the corporation and in the effectiveness of its governing body. Corporate governance is likely to work best in supporting the creation of value when the decision rights and responsibilities of shareholders and boards set out in state corporate law are effectuated.

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Sealing the Deal

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, February 14, 2014
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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, and is based on a Morris Nichols publication by Melissa A. DiVincenzo. 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 many jurisdictions, a statute of limitations may not be extended by contract. [1] Delaware follows this rule, so its three-year statute of limitations for contract claims generally may not be extended. [2] Moreover, under Delaware’s borrowing statute, contract claims arising outside of Delaware but litigated in a Delaware court are subject to the shorter of that three-year period or the time established by the jurisdiction where the cause of action arose. [3] Notwithstanding these default rules, the statutory limitations period can be reduced by contract. [4] While many private company acquisition agreements do in fact shorten the statute of limitations for many breaches of certain representations and warranties by providing that such representations and warranties “survive” for a shorter period, it is also often the case that buyers want certain representations and indemnification obligations to “survive” longer, and in some cases, beyond the statutory period. [5] In order to achieve such a result, parties may, under Delaware law, use a so-called “specialty” contract, i.e., a contract that is entered into under seal, which will be subject to a twenty-year limitations period. [6]

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Are Stock-Financed Takeovers Opportunistic?

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, February 14, 2014
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The following post comes to us from B. Espen Eckbo, Professor of Finance at Dartmouth College; Tanakorn Makaew of the Department of Finance at the University of South Carolina; and Karin Thorburn, Professor of Finance at the Norwegian School of Economics.

In our paper, Are Stock-Financed Takeovers Opportunistic?, which was recently made publicly available on SSRN, we present significant new empirical evidence relevant to the ongoing controversy over whether bidder shares in stock-financed mergers are overpriced. The extant literature is split on this issue, with some studies suggesting that investor misvaluation plays an important role in driving stock-financed mergers—especially during periods of high market valuations and merger waves. Others maintain the neoclassical view of merger activity where takeover synergies emanate from industry-specific productivity shocks. This debate is important because opportunities for selling overpriced bidder shares may result in the most overvalued rather than the most efficient bidder winning the target—distorting corporate resource allocation through the takeover market.

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Will The New Shareholder-Director Exchange Achieve Its Potential?

Posted by Carl Icahn, Icahn Enterprises, on
Thursday, February 13, 2014
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Carl Icahn is the majority shareholder of Icahn Enterprises. The following post is based on a commentary featured today at the Shareholders’ Square Table.

The recent announcement of the formation of the Shareholder-Director Exchange, a new group that aims to facilitate direct communication between institutional shareholders (namely, mutual funds and pension programs) and non-management directors of the U.S. public companies they own, has been accompanied by a flurry of articles regarding the purposes and possibilities of this new group. From my perspective, the Shareholder-Director Exchange has tremendous potential to help improve corporate governance and performance in this country.

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Shareholder Activism: 2013 and Beyond

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, February 13, 2014
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The following post comes to us from Marc Weingarten and David E. Rosewater, partners and co-heads of the shareholder activism practice at Schulte Roth & Zabel LLP, and is based on their article “Shareholder Activism: 2013 and beyond,” which appeared in The Activist Investing Annual Review 2014, published by Activist Insight in association with Schulte Roth & Zabel LLP. The complete publication is available here.

Schulte Roth & Zabel’s Shareholder Activism practice was at the forefront of the industry in 2013, advising our clients in a number of proxy contests. These are our observations from a busy year.

Rapid growth with many new entrants

By almost any measure, shareholder activism became more popular in 2013 than ever. With assets under management quickly growing and returns consistently outperforming the average hedge fund, the activist sector has seen an influx of new activist-oriented funds. As activist investors have appeared on the cover of Time magazine and filled the pages of Vanity Fair throughout the year, it is clear that investors and boards are not the only ones interested in learning more about shareholder activism.

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Bank Capital and Financial Stability

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, February 13, 2014
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The following post comes to us from Anjan Thakor, Professor of Finance at Washington University in Saint Louis.

In the paper, Bank Capital and Financial Stability: An Economic Tradeoff or a Faustian Bargain?, forthcoming in the Annual Review of Financial Economics, I review the literature on the relationship between bank capital and stability. Higher capital contributes positively to financial stability. On this issue, there seems to be little disagreement. There is, however, disagreement in the literature on whether the high leverage in banking serves a socially-useful economic purpose, and whether regulators should permit banks to operate with such high leverage despite its pernicious effect on bank stability, and this disagreement seems at least as strong as that over the causes of the subprime crisis (Lo (2012)). Some of the disagreement over higher capital requirements is between those who emphasize the potential benefits of this in terms of reducing systemic risk and those who believe that sufficiently high capital requirements will generate various costs (e.g., lower lending and liquidity creation and the migration of key financial intermediation services to the unregulated sector).

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Disqualifying Dissident Nominees: A New Trend in Incumbent Director Entrenchment

Posted by Carl Icahn, Icahn Enterprises, on
Wednesday, February 12, 2014
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Carl Icahn is the majority shareholder of Icahn Enterprises. The following post is based on a commentary featured today at the Shareholders’ Square Table.

There are many good, independent boards of directors at public companies in the United States. Unfortunately, there are also many ineffectual boards composed of cronies of CEOs and management teams, and such boards routinely use corporate capital to hire high-priced “advisors” to design defense mechanisms, such as the staggered board and poison pill, that serve to insulate them from criticism. Recently, these advisors have created a particularly pernicious new mechanism to protect their deep-pocketed clients—a bylaw amendment (which we call the “Director Disqualification Bylaw”) that disqualifies certain people from seeking to replace incumbent members of a board of directors. Under a Director Disqualification Bylaw, a person is not eligible for election to the board of directors if he is nominated by a shareholder and the shareholder has agreed to pay the nominee a fee, such as a cash payment to compensate the nominee for taking the time and effort to seek election in a proxy fight, or compensation that is tied to performance of the company. [1]

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Motivating Innovation in Newly Public Firms

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, February 12, 2014
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The following post comes to us from Nina Baranchuk and Robert Kieschnick, both of the Finance and Managerial Economics Area at the University of Texas at Dallas, and Rabih Moussawi of the Wharton School at the University of Pennsylvania.

How do shareholders motivate managers to pursue innovations that result in patents when substantial potential costs exist to managers who do so? This question has taken on special importance as promoting these kinds of innovations has become a critical element of not only the competition between companies, but also the competition between nations. In our paper, Motivating Innovation in Newly Public Firms, forthcoming in the Journal of Financial Economics, we address this question by providing empirical tests of predictions arising from recent theoretical studies of this issue.

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Executives’ ‘Off-the-Job’ Behavior, Corporate Culture, and Financial Reporting Risk

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, February 11, 2014
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The following post comes to us from Robert Davidson of the Accounting Area at Georgetown University, Aiyesha Dey of the Department of Accounting at the University of Minnesota, and Abbie Smith, Professor of Accounting at the University of Chicago.

In our paper, Executives’ ‘Off-the-Job’ Behavior, Corporate Culture, and Financial Reporting Risk, forthcoming in the Journal of Financial Economics, we examine how and why two aspects of top executives’ behavior outside the workplace, as measured by their legal infractions and ownership of luxury goods, are related to the likelihood of future misstated financial statements, including fraud and unintentional material reporting errors. We investigate two potential channels through which executives’ outside behavior is linked to the probability of future misstatements: (1) the executive’s propensity to misreport (hereafter “propensity channel”); and (2) changes in corporate culture (hereafter “culture channel”).

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