Monthly Archives: September 2016

The Law and Brexit VI

Thomas J. Reid is Managing Partner of Davis Polk & Wardwell LLP. This post is based on a Davis Polk memorandum. Additional posts on the legal and financial impact of Brexit are available here.

Despite a weekend of Brexit brainstorming by the Cabinet at the Prime Minister’s country retreat, we are still no closer to understanding the Government’s preferred trading model for Brexit Britain.

Meanwhile, many Brexiteers in the Parliament and the Press have pointed to some positive economic data as proof that fears about the economic impact of Brexit were grossly exaggerated. Others point out that uncertainty about the political and regulatory impact of Brexit will eventually take its toll on key sectors of the British economy, including financial services.

In this post, we take a look at the key features of the “Swiss model” and, in particular, its implications for financial services post-Brexit. Unlike many other areas of the trading relationship, there is no specific bilateral agreement covering financial services between the EU and Switzerland; Switzerland relies almost entirely on the third-country access regimes in existing EU sectoral legislation. Nevertheless, the Swiss model serves to illustrate some of the key benefits and pitfalls of relying on third-country provisions in EU financial services legislation.

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Being Surprised by the Unsurprising: Earnings Seasonality and Stock Returns

Tom Y. Chang is Assistant Professor of Finance and Business Economics at the University of Southern California Marshall School of Business. This post is based on a recent paper by Professor Chang; Samuel M. Hartzmark, Assistant Professor of Finance at University of Chicago Booth School of Business; David H. Solomon, Assistant Professor of Finance and Business Economics at the University of Southern California Marshall School of Business; and Eugene F. Soltes, Jakurski Family Associate Professor of Business Administration at Harvard Business School.

“Day-to-day fluctuations in the profits of existing investments, which are obviously of an ephemeral and non-significant character, tend to have an altogether excessive, and even an absurd, influence on the market. It is said, for example, that the shares of American companies which manufacture ice tend to sell at a higher price in summer when their profits are seasonally high than in winter when no one wants ice.”

– John Maynard Keynes (1936)

The fact that obvious information should be incorporated into the price of a stock seems…obvious. If information seems obvious at first glance, but in fact requires significant thought to understand, this information may not be reflected in a stock’s price. In this case the apparent obviousness of a given piece of information causes a person to feel as if they understand it and dismiss it without given the thought necessary to truly understand its content.

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Evaluating Monetary Policy Operational Frameworks

Simon Potter is the Head of the Markets Group at the Federal Reserve Bank of New York. This post is based on Mr. Potter’s recent remarks at the 2016 Economic Policy Symposium. The complete text, including footnotes, is available here. This post relates to a recent paper, Evaluating monetary policy operational frameworks, by Ulrich Bindseil of the European Central Bank. The views expressed in this post are those of Mr. Potter and do not necessarily reflect those of the Federal Open Market Committee or the Federal Reserve System.

Thank you for giving me the opportunity to discuss Ulrich Bindseil’s excellent paper, which builds on his considerable body of work in this field and provides an insightful discussion of monetary policy implementation. What makes Ulrich’s contributions notable is the unique combination of academic rigor and practical insights he brings to the topic. By distilling the key elements of his previous research into an accessible form, this article is a useful read for anyone who wants to gain a deeper understanding of the economics of monetary policy implementation, including practitioners of central bank market operations, central bank researchers, and academics. I expect that it will be widely read throughout the Federal Reserve System as we continue our effort to evaluate potential long-run monetary policy implementation frameworks. The remarks that follow are my own personal views and do not necessarily reflect those of the Federal Reserve Bank of New York or the Federal Reserve System.

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A Gadfly’s Perspective

Jonathan Kalodimos is Assistant Professor of Finance at Oregon State University College of Business. This post is based on a recent paper authored by Professor Kalodimos. This post relates to the paper Gadflies at the Gate: Why Do Individual Investors Sponsor Shareholder Resolutions?, by David F. Larcker and Brian Tayan.

Individuals who submit shareholder proposals to companies for inclusion on their proxy statements are often characterized as nuisances. These shareholders often have little wealth at stake yet exert considerable effort and incur non‐trivial expenses in order have a shareholder proposal put to a vote—which more often than not does not support the proponent’s proposal. David Larcker and Brian Tayan explore the motivations of these investors in a recent piece, Gadflies at the Gate: Why Do Individual Investors Sponsor Shareholder Resolutions?

Larcker and Tayan (2016) struck my interest because in the 2016 proxy season I submitted 17 shareholder proposals (which I will refer to as the “project”) and by virtue of being an individual proponent—as opposed to an institutional proponent—I became a corporate gadfly. [1] Whether gadfly is a pejorative label or not is debatable, but from my engagements with roughly half of the companies that received proposals, I generally did not walk away from those conversations feeling like the executives with whom I engaged with viewed me as a nuisance. Like many other proposals submitted by individuals the project’s proposals garnered exceedingly low support—generally a paltry one or two percent—but in a number of ways I view this project as a success. My paper, written from the perspective of a gadfly, is intended to emphasize certain aspects in which a proposal put forth by an individual may be viewed as a success despite garnering low support.

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What Do Private Equity Firms Say They Do?

Vladimir Mukharlyamov is Assistant Professor of Finance at the McDonough School of Business at Georgetown University. This post is based on a forthcoming article by Professor Mukharlyamov; Paul A. Gompers, Eugene Holman Professor of Business Administration at Harvard Business School; and Steven N. Kaplan, Neubauer Family Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business.

Our new article, What Do Private Equity Firms Say They Do?, is the largest survey of private equity (PE) investors to date. While there has been much academic work on the effects of private equity, there has been relatively little analysis of actions taken by PE fund managers. We seek to fill this gap by surveying 79 private equity investors with combined assets under management of more than $750 billion about their practices in firm valuation, capital structure, governance, and value creation. Because PE investors are highly educated, have strong incentives to maximize value, and have been very successful, their practices likely also have been successful. We ask a simple question—do private equity investors do what the academy says are best practices?

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Buybacks and the Board: Director Perspectives on the Share Repurchase Revolution

Richard Fields is a Principal at Tapestry Networks. This post is based on the executive summary of a publication by Tapestry Networks and the IRRC Institute authored by Mr. Fields.

To learn how companies make decisions about share repurchases, Tapestry Networks interviewed 44 directors serving on the boards of 95 publicly traded US companies with an aggregate market capitalization of $2.7 trillion. The complete publication (available here) synthesizes these directors’ views and broader research on repurchase programs.

Report highlights include:

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Federal Court’s Denial of Excessive Fee Claims on Mutual Fund “Manager of Managers” Theory

John Donovan is partner in the litigation department at Ropes & Gray LLP. This post is based on a Ropes & Gray publication by Mr. Donovan, Robert Skinner, and Amy Roy.

On August 25, a federal court in the District of New Jersey issued a much-anticipated decision, finding after a lengthy trial that shareholder plaintiffs failed to prove claims that AXA entities had charged excessive mutual fund management fees in violation of Section 36(b) of the 1940 Act. In the first case to proceed to trial since the U.S. Supreme Court established the legal standard for these claims in its landmark 2010 decision in Jones v. Harris Associates L.P., the New Jersey trial court held in the defendants’ favor on all claims relating to twelve mutual funds operating in a “manager of managers” structure. The plaintiffs’ central theory of liability—mirrored in several other pending cases across the industry—is that AXA improperly retained a significant portion of the management fees despite delegating virtually all of the management responsibilities to external sub-advisers. Based on review of extensive documents and testimony, Judge Peter G. Sheridan rejected the premise of this theory, finding that there was ample evidence that AXA retained responsibility for a range of management services and bore significant risks in its role as fund sponsor and adviser.

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Shareholder Approval in M&A

Tingting Liu is Assistant Professor at Creighton University. This post is based on a recent paper by Professor Liu; Kai Li, W.M. Young Chair in Finance at University of British Columbia Sauder School of Business; and Juan (Julie) Wu, Assistant Professor of Finance at University of Nebraska at Lincoln.

Modern corporations are characterized by the separation of ownership and control, thus shareholder engagement in important corporate decisions is fundamental to the governance process. Despite its importance, evidence on the role of shareholder engagement in one of the most important corporate decisions—mergers and acquisitions (M&As) is limited and mixed. Our paper provides one of the first large sample studies documenting a positive causal effect of shareholder approval on corporate M&As.

In general, it is difficult to find a setting in which a firm’s governance structure changes exogenously. The challenge faced by many empirical studies is the endogeneity of a firm’s governance structure. For example, acquirers whose deals require shareholder approval may be fundamentally different from those whose deals do not require shareholder approval. A simple comparison of these two groups of acquirers only suggests possible association between shareholder approval and deal quality, but does not establish causality.
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The SEC’s Whistleblower Program: The Successful Early Years

Andrew Ceresney is Director of the Division of Enforcement, U.S. Securities and Exchange Commission. The following post is based on Mr. Ceresney’s recent address at the Sixteenth Annual Taxpayers Against Fraud Conference; the complete text, including footnotes, is available here. The views expressed in this post are those of Mr. Ceresney and do not necessarily reflect those of the Securities and Exchange Commission or its staff.

I am pleased to have the opportunity this morning [Sept. 14, 2016] to speak about the Commission’s whistleblower program to an audience so integral to that program, whistleblowers and their counsel. Whistleblowers provide an invaluable public service, often at great personal and professional sacrifice and peril. I cannot overstate the appreciation we have for the willingness of whistleblowers to come forward with evidence of potential securities law violations. I often speak of the transformative impact that the program has had on the Agency, both in terms of the detection of illegal conduct and in moving our investigations forward quicker and through the use of fewer resources. The success of the program can be seen, in part, in the over $107 million we have paid to 33 whistleblowers for their valuable assistance, in cases with more than $500 million ordered in sanctions. But it can also be seen in my daily interactions with enforcement teams who when I ask the question of how an investigation began, often respond by pointing to a whistleblower.

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Why Don’t General Counsels Stop Corporate Crime?

Sureyya Burcu Avci is a Research Scholar and H. Nejat Seyhun is Professor of Finance at University of Michigan Ross School of Business. This post is based on their recent paper.

General Counsels (GCs) are supposed to wear multiple hats and manage these hats efficiently. On the one hand, they are the top legal officer for the firm, working closely with the top management and formulating and executing the firm’s legal strategy. On the other hand, they are the corporate watchdog. Sarbanes Oxley (SOX) imposes a watchdog role for GCs since corporate attorneys must report any potential violation to the chief executive officer and if the response from these officers is inadequate, then to the board of directors to stop any potential wrongdoing. [1] The reasoning behind the SOX-imposed requirement is that GCs have a moral obligation to society at large to set the corporation in the right direction. More than any other executives in the corporation, GCs are well-versed in law and they are expected to understand violations of law and they are expected to use their legal expertise to advise, intervene and stop potential corporate wrongdoing. [2] Logically, these two hats are not only always compatible, and in fact, they may be in conflict with each other.

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