Monthly Archives: April 2016

Market Abuse in Europe: Market Sounding and “The Matrix”

Marco Ventoruzzo is a comparative business law scholar with a joint appointment with the Pennsylvania State University, Dickinson School of Law, and Bocconi University.

The European Market Abuse Regulation (No. 596/2014), which rewrites many rules governing insider trading and market manipulation, will come into full force in June 2016 in the Member States of the Union. With respect to insider trading, the underlying approach remains based on the equal access to information theory and the idea that—absent specific exemptions—everyone in possession of a price-sensitive, inside information, cannot trade without running afoul of the law, unless the information is properly disclosed when this is allowed. In this perspective, Europe can be contrasted with the U.S., where the fiduciary duty theory of insider trading has created a complex web of doctrines and rules, and caused significant uncertainty (just consider the recent certiorari granted by the Supreme Court in light of a split among Circuit Courts on the scope of tippee liability (discussed on the Forum here)). For an overview of the different approaches on the two sides of the Atlantic, also in an historical perspective, see here.

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U.S. Taxation of Related Party Debt: New Proposed Regulations

This post is based on a Sullivan & Cromwell LLP publication authored by David P. Hariton.

[On April 4, 2016], the U.S. Treasury Department issued a notice of proposed rulemaking that could significantly affect the debt capitalization of U.S. subsidiary groups owned by foreign corporations (and of foreign subsidiaries owned by U.S. corporations).

The proposed regulations would, among other things, effectively turn debt issued by a U.S. subsidiary group and held by a related foreign parent corporation into preferred equity for U.S. tax purposes, unless the debt was issued for cash that served to increase the capital of the U.S. subsidiary group, after taking any related transactions into account. For example, $1 billion of debt issued by the U.S. group to the foreign parent in exchange for $1 billion of cash would be respected as debt for tax purposes. However, such debt would not be respected as debt if (i) $1 billion of debt was simply distributed by the U.S. group to the foreign parent, (ii) $1 billion of debt was issued by the U.S. group to the foreign parent for cash, but the $1 billion of cash was later (or earlier) distributed to the foreign parent, (iii) the foreign parent sold one U.S. subsidiary to another U.S. subsidiary in exchange for $1 billion of debt in the acquirer, (iv) the foreign parent merged one U.S. subsidiary into another U.S. subsidiary in exchange for stock plus $1 billion of debt, or (v) one foreign affiliate lent $1 billion to a U.S. subsidiary and the U.S. subsidiary distributed the cash to a different foreign affiliate. The proposed regulations are broadly drafted in an effort to cover similar transactions perceived as end-runs or loopholes. These rules would likewise apply to the debt capitalization of foreign subsidiaries by U.S. parent corporations.

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SEC Guidance on Proxy Proposal C&DI

Stuart H. Gelfond is a partner in the Corporate Department at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank publication authored by Mr. Gelfond, Gail Weinstein, and Craig Bergmann.

With the 2016 proxy season rapidly approaching, on March 22, 2016, the Securities and Exchange Commission staff in the Division of Corporation Finance released a Compliance and Disclosure Interpretation (C&DI) [1] addressing the degree of specificity with which a shareholder or management proposal must be described on a company’s proxy card.

Rule 14(a)-4(a)(3) of the Securities and Exchange Act of 1934, as amended, provides that “the form of proxy … [s]hall identify clearly and impartially each separate matter intended to be acted upon … whether proposed by the registrant or by security holders.” Based on the new C&DI, overly vague, generic or generalized descriptions of Rule 14a-8 proposals will not be deemed to meet the requirement that proposals be described “clearly.”

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Aligning the Interests of Credit Rating Agencies, Proxy Advisors, and Investors

Asaf Eckstein is Adjunct Professor at Bar-Ilan University Law School, and academic fellow at the Raymond Ackerman Chair for Corporate Governance, Bar-Ilan School of Business. This post is based on a recent article authored by Professor Eckstein.

The concept of skin in the game represents a powerful mechanism for motivating agents to perform at their best. It is an incentive-based compensation that ties agents’ pay to their performance. In this author’s view, just as skin in the game has been beneficial in the context of inside agents (directors and managers), so may it be put to use with certain outside agents, like credit rating agencies and proxy advisory firms, for the benefit of investors.

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Changes to CalPERS Global Governance Principles

Pamela L. Marcogliese is a partner in the New York office of Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum by Ms. Marcogliese and Elizabeth K. Bieber.

Over the past few years there has been a significant amount of attention to the issue of director tenure, particularly focused on the intersection between tenure and entrenchment and its impact on board diversity. On the one hand, certain stakeholders advocate for experience and continuity of culture and on the other, there is the fear that a lack of turnover and refreshment prevents boards from balancing skills, strategy and diversity and adversely affects a director’s independence. Institutional investors, proxy advisory firms, shareholder activists and governance advocates have all been publicly weighing in on the debate. Recently, The California Public Employees’ Retirement System (“CalPERS”) solidified its position in the recent update of their Global Governance Principles (the “Principles”). CalPERS’ revised Principles state that “director independence can be compromised at twelve years of service.” As a result, the Principles call for companies to conduct “rigorous evaluations” of director independence, which it believes should result in either (i) classification of the director as non-independent or (ii) annual inclusion of a detailed explanation regarding why the director continues to be independent. In addition to the evaluation of individual directors, CalPERS believes there should be routine discussions and succession planning regarding board refreshment to ensure that boards continue to have the necessary mix of skills, diversity and other strategic objectives over time.

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Reallocating State Pension Liabilities to Cities and Beyond

Alicia H. Munnell is director of the Center for Retirement Research (CRR) at Boston College and the Peter F. Drucker Professor of Management Sciences at Boston College’s Carroll School of Management. Jean-Pierre Aubry is assistant director of state and local research at the CRR. This post is based on a CRR report by Ms. Munnell and Mr. Aubry.

In an effort to increase the visibility of pension commitments, the Governmental Accounting Standards Board (GASB) Statement 68 beginning in 2015: 1) moved pension funding information from the footnotes of financial statements to the balance sheets of employers; and 2) required employers that participate in so-called “cost-sharing” plans to provide information regarding their share of the “net pension liability” on their books as well. The Center for Retirement Research at Boston College recently completed a study that examined the impact of the new GASB rules on cities. Subsequently, the Center broadened the scope of the analysis and examined the impact on school districts and counties as well as cities, and the diminution of liabilities at the state level as a result of the reallocation.

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The Sovereign-Bank Diabolic Loop and ESBies

Markus Brunnermeier is Professor of Economics at Princeton University, and Marco Pagano is Professor of Economics at University of Naples Federico II. This post is based on an article authored by Professors Brunnermeier and Pagano, in collaboration with Luis Garicano, Professor of Economics and Strategy at London School of Economics; Philip R. Lane, Professor of Political Economy at Trinity College London; Ricardo Reis, Professor of Economics at London School of Economics; Tano Santos, Professor of Finance at Columbia Business School; David Thesmar, Professor of Finance at HEC Paris; Stijn Van Nieuwerburgh, Professor of Finance at NYU; and Dimitri Vayanos, Professor of Finance at London School of Economics.

From 2009 to 2012, the euro area was roiled by financial crisis. In Greece, Ireland, Italy, Portugal, and Spain, perceptions of euro area sovereigns’ default risk shot up; banks approached insolvency and struggled to obtain funding. The “diabolic loop” between the credit risk of sovereigns and that of banks was a hallmark of the crisis. In our paper, forthcoming in the American Economic Review: Papers and Proceedings, we propose a simple model of this sovereign-bank diabolic loop, and show that it can be avoided by restricting banks’ domestic sovereign exposures relative to their equity. Furthermore, we show that equity requirements can be reduced if banks only hold the senior tranche of an internationally diversified sovereign portfolio—known as ESBies (European Safe Bonds) in the euro-area context.

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M&A Agreements and the Challenges of PRC Acquirors

Ethan A. Klingsberg is a partner in the New York office of Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb publication by Mr. Klingsberg and Rob Gruszecki.

Companies based in the People’s Republic of China have committed to over $100 billion of overseas acquisitions since January 1, 2016, including a number of high profile targets in the United States and Europe. [1] The ties of these buyers to governmental entities in the PRC, coupled with the unpredictability of the PRC government, and the challenges that a non-PRC counterparty faces when seeking to enforce contractual obligations and non-PRC judgments in PRC courts has led practitioners to implement an array of innovative provisions in M&A Agreements.

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13 Observations about the SEC’s Enforcement Program

Jonathan N. Eisenberg is partner in the Government Enforcement practice at K&L Gates LLP. This post is based on a K&L Gates publication by Mr. Eisenberg.

Over the last two months, the SEC issued two reports that provide useful perspectives on its enforcement program. In February, it issued the combined 136-page “FY 2017 Congressional Justification & FY 2015 Annual Performance Report and FY 2017 Annual Performance Plan.” In March, it issued its “SEC Accomplishments: April 2013–March 2016.” We glean the following important lessons from these reports:

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Rationalizing the Dodd-Frank Clawback

Jesse Fried is a Professor of Law at Harvard Law School. This post is based on an article authored by Professor Fried. Related research from the Program on Corporate Governance includes Excess-Pay Clawbacks by Jesse Fried and Nitzan Shilon (discussed on the Forum here).

In Rationalizing the Dodd-Frank Clawback, recently made publicly available on SSRN, I analyze and critique the SEC’s proposed Dodd-Frank clawback. I explain that while the proposed clawback would reduce executives’ incentives to misreport, it is too broad. The economy and investors would be better served by a more narrowly targeted “smart” excess-pay clawback that focuses on fewer issuers, executives, and compensation arrangements.

Section 954 of the 2010 Dodd-Frank Act will, when implemented, require issuers with securities listed on a national exchange to create and enforce an excess-pay clawback. In a nutshell, the Dodd-Frank clawback requires an issuer that has restated its financials to recover from a covered executive who had received “incentive-based compensation” the excess (if any) of (a) the incentive-based compensation she actually received over (b) the incentive-based compensation she would have received under the restated financials. There is no need to prove executive misconduct. On July 1, 2015, the SEC proposed a rule (Proposed Rule 10D-1) to implement the Dodd-Frank clawback. The rule has not yet been finalized.

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