Monthly Archives: April 2014

Why the Market Should Care About Proposed Clearing Agency Requirements

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 an article by Ms. Nazareth and Jeffrey T. Dinwoodie that first appeared in Traders Magazine.

On March 12, the SEC issued a 400-page rule proposal that, if adopted as proposed, would impose a multitude of new compliance requirements on The Options Clearing Corporation (“OCC”), The Depository Trust Company (“DTC”), National Securities Clearing Corporation (“NSCC”), Fixed Income Clearing Corporation (“FICC”) and ICE Clear Europe. Since these clearing agencies play a fundamental role in the options, stock, debt, U.S. Treasuries, mortgage-backed securities and credit default swaps markets, the proposed requirements have important implications for banks, broker-dealers and other U.S. securities market participants, as well as securities exchanges, alternative trading systems and other trading venues.

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The Use and Abuse of Labor’s Capital

The following post comes to us from David H. Webber of Boston University Law School.

Across the country, public employee retirement systems are investing in companies that privatize public employee jobs. Such investments lead to reduced working hours and often job losses for current employees. [1] Although, in some circumstances, pension fund participants and beneficiaries may benefit from these investments, their actual economic interests might also be harmed by them, once the negative jobs impact is taken into account. But that impact is almost never taken into account. That’s because under the ascendant view of the fiduciary duty of loyalty, pension trustees owe their allegiance to the fund first, rather than to the fund’s participants and beneficiaries. Notwithstanding the fact that ERISA and state pension codes command trustees to invest, “solely in the interests of participants and beneficiaries and for the exclusive purpose of providing benefits,” the United States Department of Labor declared in 2008 that the plain text of the quoted language means that the interests of the plan come first. [2] Under this view, plan trustees should de facto ignore the potentially negative jobs impact of privatizing investments because that impact harms plan members, and not, purportedly, the plan itself. Thus, in the name of the duty of loyalty, the actual economic interests of plan members in plan investments are subverted to the interests of the plan itself (or, at a minimum, to an unduly constrained version of the plan’s interests that excludes lost employer and employee contributions). As a result, public pension plans make investments that harm the economic interests of their members. This turns the duty of loyalty on its head.

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Three Courts Dismiss Lawsuits for Lack of Subject Matter Jurisdiction

The following post comes to us from Yafit Cohn, Associate at Simpson Thacher & Bartlett LLP, and is based on a Simpson Thacher memorandum; the full text, including footnotes, is available here.

This proxy season, rather than following the traditional route of seeking no-action relief from the Securities and Exchange Commission (“SEC”) (or, in one instance, after receiving a no-action denial), at least four companies have filed lawsuits against activist investor John Chevedden, in each case requesting declaratory judgment that the company may properly exclude Chevedden’s proposed shareholder resolution from the proxy materials for its 2014 annual meeting. While companies have enjoyed judicial victories against Chevedden in the recent past (including during the current proxy season), this month, for the first time, three federal courts dismissed actions against Chevedden, citing lack of subject matter jurisdiction.

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What It Takes for the FDIC SPOE Resolution Proposal to Work

The following post comes to us from Karen Petrou, co-founder and managing partner of Federal Financial Analytics, Inc., and is based on a letter and a FedFin white paper submitted to the FDIC by Ms. Petrou; the full texts are available here.

In a comment letter and supporting paper to the FDIC on its single-point-of-entry (SPOE) resolution concept release, Karen Shaw Petrou, managing partner of Federal Financial Analytics, argues that SPOE is conceptually sound and statutorily robust. However, progress to date on orderly liquidation has been so cautious as to cloud the credibility of assertions that the largest U.S. financial institutions, especially the biggest banks, are no longer too big to fail (“TBTF”). Crafting a new resolution regime is of course a complex undertaking that benefits from as much consensus as possible. However, if definitive action is not quickly taken on a policy construct for single-point-of-entry resolutions resolving high-level questions about its practicality and functionality under stress, markets will revert to TBTF expectations that renew market distortions, place undue competitive pressure on small firms, and stoke systemic risk. Even more dangerous, the FDIC may not be ready when systemic risk strikes again.

Questions addressed in detail in the paper and Ms. Petrou’s answers to them are summarized below:

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To-may-to To-mah-to: 10 Surprises for a US Bidder on a UK Takeover

The following post comes to us from Stephen Cooke, partner and head of the Mergers and Acquisitions practice at Slaughter and May, and is based on a Slaughter and May publication by Mr. Cooke.

“You like to-may-to and I like to-mah-to…
Potato, potahto, tomayto, tomahto
Let’s call the whole thing off”

(“Let’s Call The Whole Thing Off” by George & Ira Gershwin, 1937)

Two nations divided by a common tongue. In M&A, as in so many spheres, common language and terminology often give rise to the assumption that the architecture is similarly homogenous. Although the US and the UK have a number of similarities in terms of capital markets and business practices, there are fundamental divergences in approach to public takeover practice and regulation.

Consistent with the title of this post, I have used the great American songbook as an entry point to this guide to the ten principal differences between takeover practice and regulation in the US and the UK.

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The Case for Consumer-Oriented Corporate Governance, Accountability and Disclosure

The following post comes to us from Shlomit Azgad-Tromer of Tel Aviv University—Buchmann Faculty of Law.

When offering securities to the public, corporations must comply with an exclusive informational regime that allows speech only within the uniform boundaries determined by the SEC. Corporations must use a standardized method for financial audit and report, and disclose in plain and simple English any material fact of interest to a potential buyer. But when offering the public other products, corporations are entitled to speak freely to consumers as they wish, under the wide wings of the freedom of commercial speech, constrained merely by the ban on misrepresentation and fraud. Why are investors better protected than consumers? Why does our legal system choose to provide consumers of investments better information to secure their freedom of choice?

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Dodd-Frank Rules Impact End-Users of Foreign Exchange Derivatives

The following post comes to us from Michael Occhiolini, partner focusing on corporate finance, corporate law and governance, and derivatives at Wilson Sonsini Goodrich & Rosati, and is based on a WSGR Alert memorandum. The complete publication, including annexes, is available here.

This post is a summary of certain recent developments under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) that impact corporate end-users of over-the-counter foreign exchange (FX) derivative transactions and should be read in conjunction with the four prior WSGR Alerts on Dodd-Frank FX issues from October 2011, September 2012, February 2013, and July 2013.

Title VII of Dodd-Frank amended the Commodity Exchange Act (CEA) and other federal securities laws to provide a comprehensive new regulatory framework for the treatment of over-the-counter derivatives, which are generally defined as “swaps” under Section 1a(47) of the CEA. Among other things, Dodd-Frank provides for:

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The Misrepresentation of Earnings

The following post comes to us from Ilia Dichev, Professor of Accounting at Emory University; John Graham, Professor of Finance at Duke University; Campbell Harvey, Professor of Finance at Duke University; and Shivaram Rajgopal, Professor of Accounting at Emory University.

While hundreds of research papers discuss earnings quality, there is no agreed-upon definition. We take a unique perspective on the topic by focusing our efforts on the producers of earnings quality: Chief Financial Officers. In our paper, The Misrepresentation of Earnings, which was recently made publicly available on SSRN, we explore the definition, characteristics, and determinants of earnings quality, including the prevalence and identification of earnings misrepresentation. To do so, we conduct a large-scale survey of 375 CFOs on earnings quality. We supplement the survey with 12 in-depth interviews with CFOs from prominent firms.

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Perspectives on Strengthening Enforcement

Mary Jo White is Chair of the U.S. Securities and Exchange Commission. This post is based on Chair White’s remarks to the Annual Forum of the Australian Securities and Investments Commission (ASIC), available here. The views expressed in this post are those of Chair White and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

Greg [Tanzer, ASIC Commissioner] suggested that I talk about my perspectives on international cooperation in the enforcement context, as well as what we at the SEC are doing to try to make our own enforcement program even more robust and responsive to the issues presented by interconnected and fast moving markets. I am happy to do that. But, before I do, I would like to share a couple of thoughts on the topic of your first session—“Enforcement—does the punishment fit the crime?”

Much of my professional background has been in enforcement and strong enforcement was one of my primary focuses when I became Chair of the SEC almost a year ago and it remains so. Vigorous enforcement of the securities laws in the United States, in Australia and around the world is obviously a critical component of our investor protection mission.

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There Is Something Special about Large Investors

The following post comes to us from Marco Da Rin of the Department of Finance at Tilburg University and Ludovic Phalippou of Saïd Business School, University of Oxford.

It has been argued that the best private equity partnerships do not increase fund size or fees to market-clearing levels. Instead they have rationed access to their funds to favor their most prestigious investors (e.g. Ivy League university endowments). Further, industry observers (e.g. Swensen (2000)) have often argued that endowments are better equipped to assess and evaluate emerging alternative investments, such as private equity, in which asymmetric information problems are especially severe. Lerner, Schoar, and Wongsunwai (2007) document that improved access as well as experience of investing in the private equity sector led endowments to outperform other institutional investors substantially during the 1990s. However, private equity is no longer an emerging, unfamiliar asset class, and the distribution of private equity fund returns has also changed over time. In particular, venture capital returns fell dramatically after the technology bust of the early 2000s.

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