Monthly Archives: May 2016

CFPB Proposed Rulemaking on Arbitration Clauses

Posted by Brad Karp, Paul, Weiss, Rifkind, Wharton & Garrison LLP, on
Wednesday, May 18, 2016
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Brad S. Karp is chairman and partner at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul Weiss client memorandum by Mr. Karp, Roberto Gonzalez, Elizabeth Sacksteder, Jay Cohen, and Jane O’Brien. The complete publication, including footnotes, is available here.

On May 5, 2016, the Consumer Financial Protection Bureau (CFPB) released a 377-page notice of proposed rulemaking that would prohibit, going forward, banks and a variety of other companies from including in contracts arbitration clauses that would prevent consumers from filing or participating in class-action litigation. According to the press release: “With this contract gotcha, companies can sidestep the legal system, avoid accountability, and continue to pursue profitable practices that may violate the law and harm countless consumers.” The proposed regulation would continue to allow companies to insist on arbitration instead of individual litigation, but would require companies to submit records related to arbitrations to CFPB for monitoring and for potential posting in some form on its website. The public will have 90 days to comment on the proposal once it is published in the Federal Register.

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The Ability of Pre-IPO Companies to Stay Private Longer

Posted by Joseph A. Hall, Davis Polk & Wardwell LLP, on
Wednesday, May 18, 2016
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Joseph A. Hall is a partner and head of the corporate governance practice at Davis Polk & Wardwell LLP. This post is based on a Davis Polk memorandum authored by Mr. Hall, Alan F. Denenberg, Michael Kaplan, Richard D. Truesdell, Jr., and Michele Luburich.

On May 3, the SEC approved rule amendments that will make it easier for many private companies to remain private, and easier for some public financial companies to terminate their SEC reporting obligations. With the adoption of these amendments, the SEC has completed the rulemaking mandated by Congress under the JOBS Act of 2012.

The amendments:

  • Increase numerical thresholds for triggering SEC reporting by pre-IPO companies, based on the extent to which the company’s investor base includes “accredited investors” and employee shareholders—providing some companies with the flexibility to stay private longer and develop a larger shareholder base before conducting an IPO;
  • Allow companies, when counting their shareholders to see if they are required to register with the SEC, to exclude securities held by persons who received them under equity compensation plans in transactions not subject to SEC registration; and
  • Make it easier for some banks, bank holding companies and savings and loan holding companies to exit the SEC reporting regime, based on the size of their shareholder base.

The amendments will become effective on June 9, 2016.

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The Fed’s Deeply Flawed Strategy for Resolving Failed Megabanks

Posted by Arthur E. Wilmarth, Jr., George Washington University Law School, on
Wednesday, May 18, 2016
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Arthur E. Wilmarth, Jr. is a Professor of Law at the George Washington University Law School. This post is based on a recent article by Professor Wilmarth.

In my article SPOE + TLAC = More Bailouts for Wall Street, which was recently published in the Banking & Financial Services Policy Report, I discuss a new strategy that the Federal Reserve Board (Fed) has proposed for dealing with failures of global systemically important banks (G-SIBs). My article points out a number of serious shortcomings in the Fed’s proposal and argues that significant reforms must be made before the plan is implemented.

A primary goal of the Dodd-Frank Act is to end “too big to fail” (TBTF) bailouts for systemically important financial institutions (SIFIs) and their creditors. Title II of Dodd-Frank establishes the Orderly Liquidation Authority (OLA), which empowers the Secretary of the Treasury to appoint the Federal Deposit Insurance Corporation (FDIC) as receiver for failed SIFIs. Title II requires the FDIC to liquidate failed SIFIs and to impose any resulting losses on their shareholders and creditors. Title II establishes a liquidation-only mandate because Congress did not want a failed megabank to emerge from an OLA receivership as a “rehabilitated” SIFI.

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Frozen Charters

Posted by Scott Hirst, Harvard Law School, on
Tuesday, May 17, 2016
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Scott Hirst is a Lecturer on Law at Harvard Law School, and an Associate Director of the Harvard Law School Program on Corporate Governance. This post is based on his recent article, available here.

Earlier this month, mega-cap oil refining corporation Phillips 66, also known for its Conoco and “76” gas stations, put forward an amendment to its charter, the central document establishing the internal rules of the corporation. The board of directors and management of Phillips 66 supported and recommended the change. At the company’s annual meeting, more than 98% of the votes cast were in favor of the amendment. But the amendment failed. The company’s charter is frozen.

(Disclosure: The amendments at Phillips 66, and those at many other companies with frozen charters, followed engagement by clients of the Shareholder Rights Project during the years 2011 to 2014, during which time I served as the Project’s Associate Director). [1]

This result is the consequence of a 2012 change in New York Stock Exchange policies relating to broker voting rules. Although the change was intended to protect investors and improve corporate governance, it has had the opposite effect: a significant number of U.S. public companies are no longer able to amend important parts of their corporate charters, despite the support of their boards of directors and overwhelming majorities of shareholders. Their charters are frozen.

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Corporate Use of Social Media

Posted by Matteo Tonello, The Conference Board, Inc., on
Tuesday, May 17, 2016
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Matteo Tonello is managing director at The Conference Board, Inc. This post relates to an issue of The Conference Board’s Director Notes series by Michael Jung, James Naughton, Ahmed Tahoun, and Clare Wang.

While companies devote considerable effort to creating and managing social media presences, little is known about how they use social media to communicate financial information to investors. This report examines the use of social media by S&P 1500 companies to disseminate financial information and the response from investors and traditional media. The findings show that companies use social media to overcome a perceived lack of traditional media attention and that social media usage improves the company’s information environment. There is also evidence that, in contrast with other types of company communications, the beneficial effects of social media on the company’s information environment are offset when the investor-focused social media communications are disseminated by other social media users. The findings are relevant for managers and boards establishing corporate social media disclosure policies, since they suggest that companies may benefit from developing different approaches to disseminating positive versus negative earnings news.

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The Shadow Cost of Bank Capital Requirements

Posted by Asaf Manela, Washington University in St. Louis, on
Tuesday, May 17, 2016
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Asaf Manela is Assistant Professor of Finance at Washington University in St. Louis. This post is based on a recent article by Professor Manela and Roni Kisin, Assistant Professor of Finance at Washington University in St. Louis, available here.

Capital requirements are an important tool in the regulation of financial intermediaries. Leverage amplifies shocks to the value of an intermediary’s assets, increasing the chance of distress, insolvency, and costly bailouts. Following the recent financial crisis, prominent economists and policy makers have called for a substantial increase in capital requirements for financial intermediaries. Nevertheless, proposals to increase capital requirements face fierce and successful opposition from financial intermediaries, apparently driven by their private costs of capital requirements. Despite the central role of these costs in shaping the regulation, they have not been measured empirically.

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Defending Director Discretion

Posted by Eric Geringswald, Corporation Service Company, on
Monday, May 16, 2016
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Eric Geringswald is Director of CSC® Publishing at Corporation Service Company. This post is an excerpt from the 2016 Edition of The Directors’ Handbook, by Thomas J. Dougherty of Skadden, Arps.

In this year’s Foreword, Dougherty examines three developments that increasingly impact director discretion: the threatened demise of derivative court case protections; increasing judicial skepticism toward settlements of challenges to corporate disclosure; and the potential intrusion of SEC whistleblower protocols into corporate arenas.

The Impact of Funds

Of all the forms of institutional investor, mutual funds have become the dominant owners of U.S. corporations, largely due to invested 401K personal pension capital. Mutual funds currently hold approximately 30 percent of U.S. corporate shares, versus less than 10 percent twenty-five years ago. Yet, those families and complexes of mutual funds, with rare exception, do not assert control over corporate governance of the businesses they invest in.

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Systemic Financial Degradation Due to the Structure of Corporate Taxation

Posted by Mark J. Roe, Harvard Law School, and Michael Tröge, ESCP-Europe, on
Monday, May 16, 2016
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Mark J. Roe is the David Berg Professor of Law at Harvard Law School, and Michael Tröge is Professor of Finance at ESCP-Europe. This post is based on a recent article by Professors Roe and Tröge.

In our article, Systemic Financial Degradation Due to the Structure of Corporate Taxation, which was recently posted to SSRN, we examine how financial sector safety is undermined by the structure of the corporate tax. Regulators have sought since the 2008 financial crisis to strengthen the financial system. Yet a core source of weakness and an additional instrument for strengthening, namely the effect of the corporate tax on the choice between debt and equity, is hardly on the regulatory agenda. Current corporate tax rules allow firms to deduct the cost of debt but not the cost of equity. This penalty for equity encourages high levels of debt, lower levels of equity, and concomitantly riskier firms. But this not an inevitable property of taxation. Alternative tax schemes, that are either capital structure neutral or favor equity instead of debt, exist and have been successfully tested in other countries.

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Stock Markets, Banking Crises, and Economic Recoveries

Posted by Ross Levine, University of California, Berkeley, on
Monday, May 16, 2016
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Ross Levine is Professor of Finance at the University of California, Berkeley. This post is based on an article authored by Professor Levine; Chen Lin, Professor of Finance at the University of Hong Kong; and Wensi Xie, Assistant Professor of Finance at the Chinese University of Hong Kong.

Over twenty-five years ago, Alan Greenspan, then Chairman of the Federal Reserve System, asserted that stock markets act as a “spare tire” during banking crises, providing an alternative corporate financing channel when banking systems “go flat.”

In our paper, Spare Tire? Stock Markets, Banking Crises, and Economic Recoveries, recently featured in the Journal of Financial Economics, we provide the first assessment of three core predictions emerging from this spare tire view. The first prediction is that if firms can issue equity at low cost when banking crises limit the flow of bank loans to firms, this will ameliorate the impact of the banking crisis on firm profits and employment. Second, when a systemic banking crisis reduces lending to firms, the benefits of a sound stock market will accrue primarily to firms that depend heavily on bank loans. For those firms that do not rely on financing from banks, the crisis is less likely to harm them in the first place. Third, the spare tire view stresses that the ability of the stock market to provide financing during a banking crisis, not the size of the market before the crisis, is what matters for how well stock markets reduce the harmful effects of banking crises on corporate performance. Although bank loans might be the preferred source of financing during normal times, the spare tire view holds that when this preferred source goes “flat,” equity issuances can, at least partially, substitute for bank loans. Critically, for the stock market to play this role, the legal infrastructure must be in place before the banking system falters. To push the analogy further, it is not the use of the spare tire before the regular tire goes flat that mitigates the adverse effects of getting a flat tire; it is having a sound spare in the trunk.

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SEC and Modernizing Regulation S-K

Posted by Holly J. Gregory, Sidley Austin LLP, on
Sunday, May 15, 2016
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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 a Sidley update by Ms. Gregory, John P. Kelsh, Thomas J. Kim, Rebecca Grapsas, and Claire H. Holland. The complete publication, including footnotes and Appendix, is available here.

On April 13, 2016, the SEC issued a concept release requesting comment on existing disclosure requirements in Regulation S-K relating to a public company’s business and financial information. The concept release is part of a comprehensive “Disclosure Effectiveness Initiative” led by the SEC’s Division of Corporation Finance to review the effectiveness of public company disclosure requirements and to consider ways to improve them for the benefit of registrants and investors. The comment period will end 90 days after the concept release is published in the Federal Register.

The Concept Release

The concept release explores the following principal issues:

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