Monthly Archives: June 2018

Update on The New Paradigm: The Evolution of Stewardship Principles

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 publication by Mr. Lipton and Karessa L. Cain.

When The New Paradigm (which we prepared for the World Economic Forum) and similar corporate governance frameworks were published in 2016-17, there was a broad consensus among business leaders and investors on the critical need to restore a long-term perspective. Pervasive and acute pressures for near-term financial results have been discouraging R&D, capex, employee training and other types of expenditures that may weigh on short-term earnings but are essential for sustainable economic growth. The New Paradigm posited that both corporations and investors have important contributions to make to create an environment that facilitates long-term value creation. For their part, corporations need to demonstrate that they are well governed and have an engaged, thoughtful board and a management team diligently pursuing a credible, long-term business strategy. In return, investors should embrace stewardship principles and provide the support and patience that such companies require to pursue long-term strategies. Working together, these stakeholders can recalibrate systemic norms and expectations in order to better balance short-term and long-term horizons.

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George Stigler on His Head: The Consequences of Restrictions on Competition in (Bank) Regulation

Prasad Krishnamurthy is Professor of Law at the U.C. Berkeley School of Law. This post is based on a recent article by Professor Krishnamurthy, forthcoming in the Yale Journal on Regulation.

Like many pieces of financial legislation, the Dodd-Frank Act of 2010 was passed in the aftermath of a major financial crisis. Such crises have been a recurring feature of U.S. economic and political history since at least the nineteenth century. Nevertheless, it is only their aftermath, when the embers of the financial system are still aglow, that the necessary public support may exist for fundamental legislative reform. Once the crisis passes, memories fade and the public turns its attention to other matters, political and otherwise. The financial industry can then look forward to a period of benign neglect, during which it can more decisively influence Congress and the federal agencies.

The immediate aftermath of financial crises are an exception to the public-choice rule, articulated by George Stigler, that regulation mostly exists for the benefit of the regulated industry. Most major pieces of financial regulation—from the National Bank Act of 1864 on up to the Federal Reserve Act of 1914, the Banking Acts of 1933 and 1935, and the Dodd-Frank Act of 2010—imposed substantial costs on powerful, incumbent financial interests. In the periods between crises, however, the banking industry is better able to preserve opportunities for profit. For example, few would dispute the idea that the Interest Rate Adjustment Act of 1966, which set maximum rates of interest on deposit and savings accounts, ultimately redounded to the benefit of the banking industry.

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Sandbagging in Delaware

Daniel E. Wolf is a partner at Kirkland & Ellis LLP. This post is based on their Kirkland & Ellis memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

In the private M&A context, “sandbagging” refers to a buyer, who despite having knowledge of a breach of representation or warranty by a seller at some time before closing, proceeds with the closing and then seeks indemnification from the seller for the breach of representation or warranty of which it had prior knowledge.

The popular belief among dealmakers has been that Delaware is generally “pro-sandbagging” meaning that, absent an express provision barring post-closing claims for known breaches (i.e., an “anti-sandbagging provision”), pre-closing knowledge of a breach is not a bar to seeking indemnification recovery as actual reliance by the buyer on the false representation is not a requisite component of a breach claim. Vice Chancellor Laster, in a 2015 transcript ruling, appeared to support this approach, saying:

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Observations on Culture at Financial Institutions and the SEC

Jay Clayton is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Clayton’s recent remarks, available here. The views expressed in this post are those of Mr. Clayton and do not necessarily reflect those of the Securities and Exchange Commission or its staff.

Thank you Bill [Dudley] for that kind introduction and for inviting me to speak today [June 18,2018]. [1] I’m planning to speak for fifteen or so minutes and to open the floor to questions.

I want to extend my congratulations to Bill Dudley on a very successful term. You are now a member of the long line of former leaders and perpetual culture carriers at the New York Fed. The respect for the New York Fed, among national and international regulators and, importantly, market participants of all stripes, is remarkable, but clearly well deserved. Congratulations are also in order for John Williams, who begins his term today. John, my colleagues and I at the SEC are looking forward to working with you in your new role.

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Audit Tenure and the Timeliness of Misstatement Discovery

Zvi Singer is associate professor of accounting at HEC Montreal, and Jing Zhang is assistant professor of accounting at the University of Alabama in Huntsville. This post is based on their recent article, published in The Accounting Review.

Is long auditor tenure beneficial or detrimental for audit quality? This is the question we are trying to address in this article. The impact of audit firm tenure and auditor rotation on audit quality have long been debated both within academia and by regulators in the US and globally. The debate has centered on two main opposing views. The positive view argues that longer auditor tenure leads to a higher quality audit via a learning effect, due to the accumulation of client-specific knowledge over time. An auditor that is more knowledgeable of the client is more likely to promptly identify financial reporting problems. Accordingly, regulatory intervention that limits the length of the auditor-client engagement is undesirable. The negative view argues that long auditor tenure may have a detrimental effect on audit quality for two reasons. First, long auditor tenure may lead to the development of economic and social bonds between the auditor and the client company due to continuous involvement. This, in turn, has the potential to impair the auditor’s objectivity and increase the likelihood of audit failure. Second, because the audit is performed year in and year out, the auditor may become complacent, due to the repetitive nature of the task. A complacent auditor, in turn, may fail to promptly detect misreporting, leading to audit failure. In contrast, a new auditor would bring a fresh viewpoint, which will benefit the audit engagement. Consequently, under the negative view, it is desirable to limit the length of the auditor-client engagement.

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Understanding the Dutch Poison Pill

Seve Jan van der Graaf is an analyst at Glass, Lewis & Co. This post is based on a Glass Lewis publication by Mr. van der Graaf.

Related research from the Program on Corporate Governance includes Toward a Constitutional Review of the Poison Pill by Lucian Bebchuk and Robert J. Jackson, Jr. (discussed on the Forum here), and The Case Against Board Veto in Corporate Takeovers by Lucian Bebchuk.

Ahold Delhaize, the biggest food retail group in the Benelux region with a rough market cap of €25 billion, is facing pushback from shareholders over a unique Dutch practice. The company recently announced that it had extended its call option agreement with a foundation called “Stichting Continuïteit Ahold Delhaize” or “SCAD” (roughly translated as the foundation for continuity of Ahold Delhaize), without giving investors the opportunity to vote on the deal.

To be clear, SCAD is not a charitable foundation—instead, the entity effectively functions as a poison pill for Ahold Delhaize. In Dutch corporate law, foundations need to have a purpose, but that purpose does not need to include the public good. As a result, these legal structures are the go-to anti-takeover mechanisms for Dutch companies, from family-owned entities to public issuers, taking several different forms. Here, SCAD was established for the purpose of protecting the continuity, independence and identity of Ahold Delhaize. It fulfils this purpose through the call option agreement, which gives SCAD the right to buy all 2,250 million of Ahold Delhaize’s authorised but unissued cumulative preference shares—which, not coincidentally, amount to 50% of the company’s authorised share capital, effectively blocking any attempt to take control.

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The Effect of Enforcement Transparency: Evidence from SEC Comment-Letter Reviews

Miguel Duro is Assistant Professor of Accounting and Control at University of Navarra IESE Business School, Jonas Heese is Assistant Professor of Business Administration at Harvard Business School, and Gaizka Ormazabal is Associate Professor of Accounting and Control at University of Navarra IESE Business School. This post is based on their recent paper.

Regulators increasingly rely on policies to disseminate their oversight actions, with the assertion that the disclosure of regulatory oversight activities can enhance the effect of enforcement by increasing third-party monitoring. However, the validity of this assertion has rarely been tested. In this study, we examine the effect of the public disclosure of the Securities and Exchange Commission (SEC) oversight activities on firms’ financial reporting. Specifically, we exploit a major change in the SEC’s policy regarding comment-letter reviews (henceforth “CLs” or “CL reviews”). Contrary to its prior policy, the SEC announced in 2004 that it would begin to publicly disseminate all CLs. From a research-design perspective, our setting provides three strengths: (1) the change was unexpected, (2) affected all public firms (all public firms are subject to CL reviews at least once every three years), and (3) did not modify the underlying regulation, but simply required the disclosure of CLs.

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T. Rowe Price’s Investment Philosophy on Shareholder Activism

Donna F. Anderson is Head of Corporate Governance at T. Rowe Price. This post is based on a T. Rowe Price memorandum by Ms. Anderson and Eric Veiel. 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 Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here).

We are long-term investors. The core of the T. Rowe Price client-centered investment philosophy is to utilize proprietary research to guide active investment selection and diversification to reduce risk. For more than 80 years, our collaborative, disciplined approach has stood the test of time.

Proprietary, fundamental research is a critical foundation of our equity investment processes, and our ability to generate unique insights about companies is, in turn, dependent on our ability to cultivate constructive, private, two-way communication with the managements of these companies over time. Therefore, as we think about the effects shareholder activism may have on our investment process, we take a very long-term perspective because well-functioning capital markets and plentiful high-quality investment opportunities are essential to the future of our investment process, our clients, and our firm.

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Significant Revisions of the Volcker Rule

Nathan S. Brownback and V. Gerard Comizio are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank publication by Mr. Brownback and Mr. Comizio.

This week, the Board of Governors of the Federal Reserve System (the “Board”), the Federal Deposit Insurance Corporation (the “FDIC”), and the Office of the Comptroller of the Currency (the “OCC”) each issued a Notice of Proposed Rulemaking (“the Notice”) proposing a number of changes to the Volcker Rule.

In summary, as described in more detail below, the Notice proposes significant changes to the Volcker Rule’s proprietary trading restrictions, a new tiered system of compliance, and a streamlined set of compliance metrics. In contrast, the Notice proposes few specific proposals for regulatory relief from the covered fund limitations and prohibitions; it primarily focuses on seeking public comment on the covered fund provisions—71 questions focus on them—but also reaffirms existing FAQs and guidance regarding the interaction of the Volcker Rule definitions of “covered fund” and “banking entity.” The existing FAQs and guidance provide some regulatory relief from the potential inclusion, in certain circumstances, of registered investment companies and foreign public funds (during their permissible seeding periods), and foreign excluded funds—none of which are covered funds—in the definition of “banking entity” under the Volcker Rule. With respect to these and other issues, the Notice requests comment on at least 342 questions related to the Volcker Rule, its scope and operations—a seemingly high number of questions for a proposed rulemaking of this type.

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Political, Social, and Environmental Shareholder Resolutions: Do they Create or Destroy Shareholder Value?

Joseph P. Kalt is the Ford Foundation Professor (Emeritus) of International Political Economy at the John F. Kennedy School of Government, Harvard University and a Senior Economist at Compass Lexecon. L. Adel Turki is a Senior Managing Director of Compass Lexecon. Kenneth W. Grant and Todd D. Kendall are Executive Vice Presidents, and David Molin is Vice President, at Compass Lexecon. The views expressed here are solely those of the authors and do not necessarily reflect the views of their employers or the National Association of Manufacturers and/or its members.

The increased use of politically-charged shareholder resolutions has garnered considerable attention in recent years, as shareholder meetings have become venues for discussion and debate regarding corporate positions and actions on issues of the day. Recent proxy seasons have seen corporate management being asked to address issues as diverse as deforestation, corporate clean energy goals, climate change, the uses of antibiotics and pesticides, political contributions, human rights risks through the supply chain, indigenous rights and human trafficking, cybersecurity, the development and reporting of sustainability metrics, and tax fairness. As we show, this change has both expanded the number of resolutions to which a given company may be required to respond and broadened the range of issues that boards and senior managers are being asked to address.

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