Monthly Archives: September 2016

The Law and Brexit V

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.

As we go to press, the UK cabinet is finally beginning the serious business of drawing up its “blueprint for Brexit”: the objectives and principles that should govern the future relationship with the EU and which will therefore drive the negotiated terms of exit. There are already reported to be tensions within Whitehall. Treasury officials, understandably, view continued access to the single market as critical for the financial sector. Others view the “European Economic Area” (“EEA”) model as unrealistic, especially if Brexiteers’ requirements for controls on immigration are to be delivered. It appears, for the moment, that priority will likely be given to immigration controls rather than market access, although the Prime Minister has made clear that the UK will seek a unique trading relationship with the EU rather than any “off the shelf” model. The real challenge for the UK negotiating team, if and when it resolves its internal differences, is whether EU governments will have the time or inclination to negotiate such a bespoke deal for the UK.

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Prosecutors in the Boardroom: Mandating Governance Reforms Through Deferred Prosecution

Jennifer H. Arlen is the Norma Z. Paige Professor of Law and Director of the Program on Corporate Compliance and Enforcement at NYU School of Law; Marcel Kahan is the George T. Lowy Professor of Law at NYU School of Law. This post is based on their forthcoming article.

Over the last decade, corporate criminal enforcement in the U.S. has undergone a dramatic transformation. Federal officials no longer simply fine publicly held firms that commit crimes. Instead, in addition to imposing a fine, prosecutors regularly use their enforcement authority to impose mandates on firms alter their internal governance.

Prosecutors generally impose mandates through pretrial diversion agreements (PDAs), specifically deferred and non-prosecution agreements. PDAs are criminal settlements that subject the firm to sanctions without formally convicting it. In return, firms usually agree to cooperate in the investigation and admit the facts of the crime.

Most PDAs contain mandates that govern the firm’s future behavior. These mandates impose new prosecutor-created duties on the firm. They may require the firm to adopt a corporate compliance program with specified features not otherwise required by law, to alter its internal reporting structure, to add specific individuals to the board of directors, to modify certain business practices, or to hire a prosecutor-approved corporate monitor.

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Taking Short-Termism Seriously: A Response to Charles Nathan

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here), and The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here).

In a recent blog post on the Conference Board Governance Center’s website, “Activists Are Not the Culprit: So Don’t Shoot the Messenger”, Charles Nathan argues that criticism of short-termism is simultaneously misguided and hopeless. We agree with his ultimate practical advice—that companies have to engage more effectively with their major institutional shareholders to persuade them of the merits of long-term strategies—but he is wrong to dismiss concerns about short-termism and to surrender to its inevitability.

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Putting Directors’ Money Where Their Mouths Are

Nitzan Shilon is Commissioner of the Israel Securities Authority and Assistant Professor at Peking University School of Transnational Law. This post is based on his recent working paper, available here. Related research from the Program on Corporate Governance includes The Case Against Board Veto in Corporate Takeovers, by Lucian Bebchuk. This post is part of the Delaware law series; links to other posts in the series are available here.

In a new paper, Putting Directors’ Money Where Their Mouths Are: A New Approach to Improving Corporate Takeover Dynamics, I put forward a new arrangement to protect shareholders from underpriced bids in takeover situations. Target boards, as stewards of the corporation who typically possess superior information about the desirability of unsolicited bids, could be expected to protect their shareholders from such bids. Unfortunately, because they have a conflict of interest with their shareholders in takeover situations, they tend to reject hostile bids to an excessive degree. Moreover, the current Delaware doctrine is ineffective in monitoring boards’ responses to takeovers, largely because boards might use selective inside information to which the courts lack access and because their judgments are backed by subjective, hard-to-attack legal and financial expert opinions that courts are ill-equipped to challenge.

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Managerial Rents vs. Shareholder Value in Delegated Portfolio Management

Youchang Wu is Associate Professor of Finance at University of Oregon Lundquist College of Business. This post is based on a forthcoming article by Professor Wu; Russ Wermers, Professor of Finance at University of Maryland Robert H. Smith School of Business; and Josef Zechner, Professor of Finance at Vienna University of Economics and Business.

There are two different organizational forms of mutual funds: closed-ended and open-ended. Closed-end funds (CEFs) issue a fixed number of shares that trade on secondary markets, while open-end funds (OEFs) issue and buy back shares at a price equal to the underlying net asset value on a daily basis. When the Investment Company Act, an overarching law governing the mutual fund industry, was enacted in 1940, the dominant form of mutual funds in the U.S. was the CEF. However, by the end of 2014, the total value of net assets managed by U.S. CEFs amounted to less than 2% of the value of net assets managed by OEFs ($289 billion versus $15.9 trillion). The predominance of the open-end structure is puzzling because, from a portfolio management perspective, the closed-end structure has many advantages. For example, it allows fund managers to take illiquid positions without worrying about money flows into or out of their funds.

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The Finer Points of Proxy Access Bylaws Come Under the Microscope

Peter Kimball is Associate Director and Head of Advisory Services, and Alexandra Higgins is a Senior Associate at ISS Corporate Solutions, a subsidiary of Institutional Shareholder Services. This post is based on an ISS Corporate Solutions publication. Related research from the Program on Corporate Governance includes The Case for Shareholder Access to the Ballot by Lucian Bebchuk; and Private Ordering and the Proxy Access Debate by Lucian Bebchuk and Scott Hirst (discussed on the Forum here).

U.S. companies’ adoption of proxy access bylaws—which give qualifying shareholders the right to nominate director candidates on the company’s proxy ballot—in response to shareholder pressure has been the big corporate governance story of 2015 and 2016.

As of August 31, 39 percent of S&P 500 companies provide a proxy access right, and 264 U.S. companies in the Russell 3000 have adopted some form of proxy access; only 16 of these companies had adopted proxy access before 2015. By summer 2017, the majority of the companies in the S&P 500 may provide proxy access, along with 15-20 percent of the S&P 400 index.

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Federal Civil Penalties Set to Increase Significantly, Many Present Retroactivity Concerns

Matthew T. Martens and Reginald J. Brown are partners at Wilmer Cutler Pickering Hale and Dorr LLP. This post is largely based on WilmerHale publication by Mr. Martens, Mr. Brown, and Daniel P. Kearney, Jr.

Over the past several months, many federal agencies have adopted rules significantly increasing the maximum civil monetary penalties (“CMPs”) they can potentially impose. The increased penalty amounts were adopted in response to recent legislation from Congress requiring that federal agencies make adjustments to “catch up” with inflation. The catch up adjustments allow agencies to increase their penalty amounts by as much as 150% of their November 2, 2015 values. In addition, agencies must make annual adjustments to their CMPs for inflation going forward.

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Political Cognitive Biases Effects on Fund Managers’ Performance

Marian Moszoro is a visiting scholar at University of California Berkeley Haas School of Business. This post is based on a recent paper by Professor Moszoro and Michael Bykhovsky of the Center for Open Economics.

Who does a better job in managing money—Democrats or Republicans? We finally have at least a partial answer.

Ideology is an important bias in the financial industry which is not usually factored in. Under rational agent hypothesis, financial industry practitioners should not be affected by political discourse. Rare events, however, may silence rationality and potentiate cognitive dissonance on a spectrum of agents.

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Crash Beliefs from Investor Surveys

Dasol Kim is Assistant Professor of Banking and Finance at Case Western Reserve University Weatherhead School of Management. This post is based on a recent paper authored by Professor Kim; William Goetzmann, Edwin J. Beinecke Professor of Finance and Management Studies, and Director of the International Center for Finance at Yale School of Management; and Robert J. Shiller, Sterling Professor of Economics at Yale University.

Investors’ beliefs about whether a severe market crash is impending can affect the prices and expected returns on risky assets, such as publicly traded stocks. However, beliefs regarding extreme market events are difficult to measure using typical economic data, precisely because they are low-probability outcomes. Observed asset prices are also determined by investor preferences, such as their degree of risk tolerance, as well as by beliefs about future outcomes. Probabilities about extreme events are usually inferred from asset prices, and disentangling probabilities from risk preferences presents problems.

In our paper, we turn to a different source of information about rare crash probabilities. Since 1989, Robert Shiller has been surveying individual and institutional investors. One question in the survey asks respondents to estimate the probability that a severe crash will occur over the next six months. The definition of a crash is specific: a drop in the U.S. stock market on the scale of October 19th, 1987 [-22.61%] or October 28th 1929 [-12.82%].

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Pay-to-Play Rules for Swap Dealers

Stephen Humenik is Of Counsel at Covington & Burling LLP. This post is based on a Covington publication by Mr. Humenik, Keir Gumbs, Robert Kelner, Zack Parks, James Kwok, and Jason Grimes.

As election season enters full swing, with political candidates at all levels actively soliciting campaign donations from individuals and companies, it is an ideal time for all companies to review the policies and procedures in place for political donations. While the SEC’s pay-to-play rules governing registered investment advisers and their “covered associates” are well known, the rules governing swap dealers are more obscure. Specifically, swap dealers and security-based swap dealers are subject to the “pay-to-play” rules of the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) respectively, which impose restrictions on the making of campaign contributions to officials of certain government entities with which a swap dealer does business.

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