Monthly Archives: March 2015

Incentive Alignment through Performance-Focused Shareholder Proposals on Management Compensation

The following post comes to us from Steve Fortin of the Accounting Area at McGill University; Chandra Subramaniam of the Department of Accounting at the University of Texas at Arlington; Xu (Frank) Wang of the Department of Accounting at Saint Louis University; and Sanjian Bill Zhang of the Department of Accountancy at California State University, Long Beach. Work from the Program on Corporate Governance about CEO pay includes: The CEO Pay Slice by Lucian Bebchuk, Martijn Cremers, and Urs Peyer (discussed on the Forum here); Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here); and Lucky CEOs and Lucky Directors by Lucian Bebchuk, Yaniv Grinstein and Urs Peyer (discussed on the Forum here).

Corporate boards are conscious of the role that executive pay practices play in improving corporate governance and increasing shareholder wealth (Gammeltoft, 2010). Economic theory suggests that the key to aligning managerial compensation with shareholder interest is to increase the sensitivity of executive compensation to firm performance (Core et al., 2005; Jensen and Meckling, 1976). Firms finance their operations, however, with funds from both shareholders and creditors, e.g., bondholders. Thus, agency theory also concerns shareholder-bondholder agency conflict and the difficulty of concurrently aligning the interests of shareholders, bondholders, and managers (Ahmed et al., 2002; Jensen and Meckling, 1976; Ortiz-Molina, 2007). In the past decade, the business press has focused on excessive CEO pay, observed during the 2001 Enron/Worldcom scandals as well as the recent 2007–2008 credit crisis, e.g., AIG. Critics contend that contracting between CEOs and boards has been shadowed by pervasive managerial influence (Bebchuk and Fried, 2005; Crystal, 1992). Consistent with these concerns, shareholders have begun to use the “shareholder proposal rule” (Rule 14a-8) established by the Securities and Exchange Commission (SEC) to defend their interest and have submitted hundreds of proposals to many of the largest U.S. corporations.

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Vice Chancellor Laster and the Long-Term Rule

The following post comes to us from Covington & Burling LLP and is based on a Covington article by Jack Bodner, Leonard Chazen, and Donald Ross. 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.

Vice Chancellor Laster has been writing for several years about the fiduciary duties of directors who represent the interests of a particular block of stockholders. In his opinion in the Trados Shareholder Litigation he found that directors, elected by the venture capital investors who held Trados’s preferred stock, had a conflict of interest in deciding on a sale of the corporation in which all the proceeds would be absorbed by the liquidation preference of the preferred and nothing would go to the common. [1] As a result of this finding, Vice Chancellor Laster applied the entire fairness standard of review to the Trados board’s decision. He concluded that while the directors failed to follow a fair process, the transaction was fair because the common stock had no economic value before the sale and so it was fair for the common stock to receive nothing from the sale. [2] In a recent Business Lawyer article which he co-authored with Delaware practitioner John Mark Zeberkiewicz, [3] Vice Chancellor Laster extended his Trados conflict of interest analysis to other situations in which directors represent stockholder constituencies with short-term investment horizons, including directors elected by activist stockholders seeking immediate steps to increase the near term stock price of the corporation. He states that such directors can face a conflict of interest between their duties to the corporation and their duties to the activists.

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Disentangling Mutual Fund Governance from Corporate Governance

The following post comes to us from Eric D. Roiter of Boston University School of Law.

Disentangling Mutual Fund Governance from Corporate Governance addresses mutual fund governance, explaining how in recent years it has become entangled with the norms and rules of corporate governance. At one level, it is understandable that mutual funds have been seen simply as a type of ordinary corporation, leading the SEC and the courts to treat mutual fund governance as simply a variation on the theme of corporate governance. Both mutual funds and corporations are separate legal entities, having directors and shareholders. Directors of each are held to fiduciary duties, charged with serving shareholders’ interests, and aspire to best practices. But there are fundamental differences between mutual funds and ordinary corporations, and this article contends that these differences have important implications for the governance of mutual funds, differences that should lead not to further entanglement of fund governance with corporate governance but to disentanglement.

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The Need for Greater Secondary Market Liquidity for Small Businesses

Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s public statement at a recent meeting of the SEC Advisory Committee on Small and Emerging Companies; 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 delighted to see that today’s [March 4, 2015] meeting will discuss the secondary trading environment for the securities of small businesses. The lack of a fair, liquid, and transparent secondary market for these securities is a longstanding problem that needs an effective solution. Indeed, I’ve spoken publicly about this very issue on a number of occasions, most recently less than two weeks ago at the annual SEC Speaks conference. This topic is increasingly urgent in light of certain new, or anticipated, Commission rules required by the JOBS Act that would result in a far wider range of small business securities needing to find liquidity in the secondary markets. Specifically, proposed rules under Regulation A-plus and Crowdfunding, and final rules under Rule 506(c) of Regulation D, would permit wide distributions of securities and also allow such securities to be freely-traded by security holders immediately upon issuance, or after a one-year holding period. These registration exemptions also provide—or are expected to provide—for lesser on-going reporting requirements than is required for listed securities.

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Delaware Poised to Embrace Appraisal Arbitrage

Trevor Norwitz is a partner in the Corporate Department at Wachtell, Lipton, Rosen & Katz and Lecturer in Law at Columbia Law School. 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.

Delaware corporations and their advisers have been eagerly awaiting the response of the Delaware legislature to the recent surge in appraisal arbitrage and judicial pronouncements allowing this activity and suggesting that lawmakers should step in if they perceive a problem. It now appears based on a proposal released by the Delaware Corporation Law Council that the legislature may act as soon as this week. If the lawmakers follow the recommendations of the Council (which they usually do) the changes will likely disappoint Delaware corporations, make mergers and acquisitions in that important state more difficult, reduce deal flow, and lead to lower prices being paid to selling shareholders. The beneficiaries of this legislation will be the small (but growing) group of short term speculators specializing in appraisal arbitrage and the advisors who support that industry. Some of the problems created by appraisal arbitrage are described in my post on this subject a few weeks ago.

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Shareholder Litigation Involving Acquisitions of Public Companies

John Gould is senior vice president at Cornerstone Research. This post discusses a Cornerstone Research report by Olga Koumrian, titled “Shareholder Litigation Involving Acquisitions of Public Companies,” which is available in full here.

A new report shows that the percentage of 2014 lawsuits filed by shareholders in M&A deals remained consistent with the previous four years, while other key indicators suggest a slowdown. The report, Shareholder Litigation Involving Acquisitions of Public Companies, released February 25, 2015 by Cornerstone Research, reveals that investors contested 93 percent of M&A transactions in 2014. Despite this typically high percentage, shareholders brought a smaller number of competing lawsuits per deal and in fewer jurisdictions, challenged fewer deals valued below $1 billion, and took slightly longer to file lawsuits.

In a significant shift from recent years, 60 percent of contested M&A deals had lawsuits filed against them in only one jurisdiction. Just 4 percent of these deals were challenged in more than two courts, the lowest number since 2007.

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German Stock Market Development, 1870-1938

Brian Cheffins is Professor of Corporate Law at the University of Cambridge. The following post is based on an article co-authored by Professor Cheffins, David Chambers of Cambridge Judge Business School, and Carsten Burhop of Max Planck Institute for Research on Collective Goods.

Since World War II, Germany’s stock market has been mostly an after-thought, despite a highly successful economy. Why might this be the case? Explanations have included the power and influence of banks, the stakeholder-oriented nature of Germany’s economy and Germany’s civil law heritage. In Law, Politics and the Rise and Fall of German Stock Market Development, 1870-1938 we argue, based on statistical analysis of a hand-collected dataset of initial public offerings (IPOs), that a combination of law and politics during the late 19th and early 20th centuries played a significant role in the evolution of German equity markets. For most of this period Germany had, contrary to the present-day pattern, a stock market that was sizeable in comparative terms. The law helped to foster this trend but legal reforms during the Nazi era reversed matters in a way that had lasting consequences.

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California Court Clarifies Scope of Class Action Judgment Reduction Provision

Brad Karp is chairman and partner at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul Weiss client memorandum.

In Rieckborn v. Velti plc, 2015 WL 468329 (N.D. Cal. Feb. 3, 2015) (Orrick, J.), the United States District Court for the Northern District of California clarified the scope of the judgment reduction provision that is found in almost all class action settlement agreements by holding that nonsettling defendants are entitled to a judgment reduction measured by the proportion of fault of all settling defendants, not just a dollar-for-dollar judgment reduction, on all settled claims under the Securities Act of 1933 (the “Securities Act”). In so holding, the court handed a major victory to nonsettling defendants in actions under the Securities Act by granting them a favorable form of judgment reduction on claims not explicitly covered by the Private Securities Litigation Reform Act of 1995 (the “PSLRA”). The court’s opinion also makes clear that bar orders cannot preclude “independent claims” and that bar orders must be “mutual,” thereby giving guidance to the drafters of class action settlement agreements.

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A European Prospectus Revolution?

David M. Lynn is a partner and co-chair of the Corporate Finance practice at Morrison & Foerster LLP. The following post is based on a Morrison & Foerster publication by Jeremy C. Jennings-Mares and Peter J. Green.

The EU prospectus regime, based on Directive 2003/71/EC (the “Prospective Directive”) as amended, has been in place now for nearly 10 years and was due to be reviewed by the European Commission by 1 January 2016. However, the European Commission has moved forward its review, and on 18 February 2015 released a consultation [1] on possible reform of the current regime, in conjunction with its Green Paper on a possible EU Capital Markets Union, released on the same date.

The main focus of the proposed EU Capital Markets Union is on improving the access to capital markets for smaller business entities (“SMEs”), in order to broaden the range of funding without the need for bank intermediation. The European Commission considers that the review of the EU prospectus regime is a vital part of developing a Capital Markets Union and, as such, has accelerated the timing of the review by launching its consultation now.

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Keeping Pace with Digital Disruption in our Securities Marketplace

Kara M. Stein is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Stein’s recent address at the Practising Law Institute’s SEC Speaks in 2015 Conference, available here. The views expressed in the post are those of Commissioner Stein and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

Before I begin my remarks, I would like to acknowledge the remarkable and dedicated career of Harvey Goldschmid. Just a few weeks ago, Harvey visited me to discuss his perspectives on a number of timely securities law issues. His superb intellect was reinforced by his engaging personality and skill as a teacher.

Harvey’s intense passion for the securities laws and investor protection was an inspiration to many of us. In authoring a tribute to Harvey Goldschmid in 2006, SEC historian Joel Seligman labeled him one of the most influential Commissioners. [1] I couldn’t agree more.

This conference provides us with an opportunity to look backward and to look forward. As I look back over the SEC’s history, I am always impressed by the rate and degree of change.

Picture Wall Street 80 years ago—the street was filled with dozens of young men—“runners”—carrying paper back and forth between various brokers and dealers and banks and exchanges and companies that made up the securities markets. Runners were the backbone of the securities market, delivering paperwork and stock certificates at a rate of $8 per day. Maybe the telephone would ring (the desk telephone was launched in 1932) or a telegram would arrive. And investors, would look to the newspaper to decide what stocks to buy or sell.

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