Author Archives: Harvard Law School Forum on Corporate Governance and Financial Regulation

The Impact of Whistleblowers on Financial Misrepresentation Enforcement Actions

By Harvard Law School Forum on Corporate Governance and Financial Regulation | Published Wednesday, March 4, 2015
Editor’s Note: The following post comes to us from Andrew Call of the School of Accountancy at Arizona State University, Gerald Martin of the Department of Finance and Real Estate at American University, Nathan Sharp of the Department of Accounting at Texas A&M University, and Jaron Wilde of the Department of Accounting at the University of Iowa.

In our paper, The Impact of Whistleblowers on Financial Misrepresentation Enforcement Actions, which was recently made available on SSRN, we investigate the effect of employee whistleblowers on the consequences of financial misrepresentation enforcement actions by the Securities and Exchange Commission (SEC) and Department of Justice (DOJ). Whistleblowers are ostensibly a valuable resource to regulators investigating securities violations, but whether whistleblowers have any measurable impact on the outcomes of enforcement actions is unclear. Using the universe of SEC and DOJ enforcement actions for financial misrepresentation between 1978 and 2012 (Karpoff et al., 2008, 2014), we investigate whether whistleblower involvement is associated with more severe enforcement outcomes. Specifically, we examine the effects of whistleblower involvement on: (1) monetary penalties against targeted firms; (2) monetary penalties against culpable employees; and (3) the length of incarceration (prison sentences) imposed against employee respondents. In addition, we investigate the effect of whistleblowers on the duration of the violation, regulatory proceedings, and total enforcement periods. We examine the effects of whistleblowers conditional on the existence of a regulatory enforcement action. This distinction is important because our tests exploit variation in consequences to SEC or DOJ enforcement with and without whistleblower involvement; we do not measure the effects of whistleblower allegations for which there are no regulatory enforcement actions.

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Proxy Access—a Decision Framework

By Harvard Law School Forum on Corporate Governance and Financial Regulation | Published Tuesday, March 3, 2015
Editor’s Note: Richard J. Sandler is a partner at Davis Polk & Wardwell LLP and co-head of the firm’s global corporate governance group. Margaret E. Tahyar is a partner in the Financial Institutions Group at Davis Polk & Wardwell LLP. This post is based on a Davis Polk client memorandum.

Recent high-profile developments have thrust proxy access back onto the agenda for many U.S. public companies. Here is a framework for how to approach the topic.

Proxy access is back in the news and back on the agenda for many U.S. public companies. Four years after the DC Circuit invalidated the SEC’s proxy-access rule, we are seeing company-by-company private ordering with a vengeance, including a record number of Rule 14a-8 shareholder proposals in the current 2015 proxy season. Events have moved at high speed in the past few weeks, leading many companies to wonder whether they should be initiating their own approach to proxy access.

As we argued in 2009 in response to an earlier SEC proxy-access proposal, we believe that each company’s approach to proxy access should be grounded in a consideration of its particular circumstances. Despite recent high-profile adoptions of proxy-access procedures, we don’t believe that most U.S. public companies should, in knee-jerk fashion, be preparing to revise their bylaws proactively. We do, however, think that boards should be assessing on an ongoing basis the broader issues of board composition, tenure and refreshment, which are not only important in their own right but also relevant to potential vulnerability to proxy-access proposals. We also think that boards should communicate a willingness to exercise their discretion in considering all shareholder suggestions regarding board membership in order to assure shareholders of a means of expressing their views and to create a level playing field for shareholders.

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Not Clawing the Hand that Feeds You

By Harvard Law School Forum on Corporate Governance and Financial Regulation | Published Tuesday, March 3, 2015
Editor’s Note: The following post comes to us from Sterling Huang, Chee Yeow Lim, and Jeffrey Ng, all of the School of Accountancy at Singapore Management University.

In our paper, Not Clawing the Hand that Feeds You: The Case of Co-opted Boards and Clawbacks, which was recently made publicly available on SSRN, we examine the impact of beholdenness of the directors to the CEO on the adoption and enforcement of clawbacks.

Clawbacks have been increasingly prevalent in recent years, and the aim of such provisions is to provide a punishment mechanism that links an executive’s compensation more closely to his or her financial reporting behavior. Clawbacks typically allow firms to recoup compensation from executives upon the occurrence of accounting restatements. Perhaps not surprisingly, the implementation and enforcement of clawbacks by companies is likely to create tensions between boards and executives because executives are unlikely to want to have a “Sword of Damocles” hanging over the compensation that is already in their pocket and are likely to resist attempts by boards to claw at this compensation when accounting restatements trigger a clawback. Hence, to better understand the use of clawbacks by firms, it is important to understand the type of boards that are more likely to implement clawbacks.

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2015 US Compensation Policies FAQ

By Harvard Law School Forum on Corporate Governance and Financial Regulation | Published Monday, March 2, 2015
Editor’s Note: Carol Bowie is Head of Americas Research at Institutional Shareholder Services Inc. (ISS). This post relates to ISS compensation policy guidelines for 2015. The complete publication is available here.

US Executive Pay Overview

1. Which named executive officers’ total compensation data are shown in the Executive Pay Overview section?

The executive compensation section will generally reflect the same number of named executive officer’s total compensation as disclosed in a company’s proxy statement. However, if more than five named executive officers’ total compensation has been disclosed, only five will be represented in the section. The order will be CEO, then the second, third, fourth and fifth highest paid executive by total compensation. Current executives will be selected first, followed by terminated executives (except that a terminated CEO whose total pay is within the top five will be included, since he/she was an within the past complete fiscal year).

2. A company’s CEO has resigned and there is a new CEO in place. Which CEO is shown in the report?

Our report generally displays the CEO in office on the last day of the fiscal year; however, the longer tenured CEO may be displayed in some cases where the transition occurs very late in the year.

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Information Networks: Evidence from Illegal Insider Trading Tips

By Harvard Law School Forum on Corporate Governance and Financial Regulation | Published Monday, March 2, 2015
Editor’s Note: The following post comes to us from Kenneth Ahern of the Finance & Business Economics Unit at the University of Southern California.

Illegal insider trading has become front-page news in recent years. High profile court cases have brought to light the extensive networks of insiders surrounding well-known hedge funds, such as the Galleon Group and SAC Capital. Yet, we have little systematic knowledge about these networks. Who are inside traders? How do they know each other? What type of information do they share, and how much money do they make? Answering these questions is important. Augustin, Brenner, and Subrahmanyam (2014) suggest that 25% of M&A announcements are preceded by illegal insider trading. Similarly, the U.S. Attorney for the Southern District of New York believes that insider trading is “rampant.”

In my paper, Information Network: Evidence from Illegal Insider Trading Tips, which was recently made publicly available on SSRN, I analyze 183 insider trading networks to provide answers to these basic questions. I identify networks using hand-collected data from all of the insider trading cases filed by the Securities and Exchange Commission (SEC) and the Department of Justice (DOJ) between 2009 and 2013. The case documents include biographical information on the insiders, descriptions of their social relationships, data on the information that is shared, and the amount and timing of insider trades. The data cover 1,139 insider tips shared by 622 insiders who made an aggregated $928 million in illegal profits. In sum, the data assembled for this paper provide an unprecedented view of how investors share material, nonpublic information through word-of-mouth communication.

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SEC’s Swaps Reporting and Disclosure Final Rules

By Harvard Law School Forum on Corporate Governance and Financial Regulation | Published Sunday, March 1, 2015
Editor’s Note: The following post comes to us from Dan Ryan, Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP, and is based on a PwC publication by Troy Paredes, Samuel Crystal, and David Kim.

On February 11, 2015, the Securities and Exchange Commission (SEC) released two final rules toward establishing a reporting and public disclosure framework for security-based swap (SBS) transaction data. The SEC’s Commissioners had voted in January to approve the rules, 3 to 2. [1] These rules are the SEC’s first substantive SBS requirements since the SEC began laying out its cross-border position through final rules in June 2014. [2] Chair White has consistently stressed the need to complete substantive SBS requirements and now appears willing to do so even when the SEC Commissioners are divided.

The SEC rules diverge from existing Commodity Futures Trading Commission (CFTC) requirements in some key ways. These divergences will create technical complexity for dealers who have built systems and processes to meet already live CFTC regulations. For example, the SEC’s broader, more exhaustive, and possibly repetitive scope of “Unique Identifier Codes” (UIC) will be problematic for market participants. A less obvious problem will be the SEC’s requirement to report SBS data within 24 hours (until modified by the SEC as the rule suggests), as dealers will likely want to delay public dissemination for as long as possible which will run counter to their existing set-ups for the CFTC requirement to report to a swap data repository (SDR) “as soon as technologically practicable.”

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Posted in Accounting & Disclosure, Derivatives, Legislative & Regulatory Developments, Practitioner Publications, Securities Regulation | Tagged , , , , , , , , , | Comments Off on SEC’s Swaps Reporting and Disclosure Final Rules

Considerations on the Use of Electronic Board Portals

By Harvard Law School Forum on Corporate Governance and Financial Regulation | Published Saturday, February 28, 2015
Editor’s Note: The following post comes to us from Sullivan & Cromwell LLP, and is based on a Sullivan & Cromwell publication.

Board portals and other mechanisms for the electronic dissemination of information to directors of public companies, non-profits and other organizations are in widespread use. Many companies have found that these portals can offer significant benefits, including improved document security, speed and ease of distribution and, for many directors, improved efficiency and ease of access to board materials.

Boards and management should be aware, however, that there is increasing discussion, including among Delaware jurists and practitioners on both the plaintiff and defense sides, concerning possible negatives associated with board portals and other electronic communications, if not properly managed. There are two areas in particular that merit thoughtful attention.

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The Difficulties of Reconciling Citizens United with Corporate Law History

By Harvard Law School Forum on Corporate Governance and Financial Regulation | Published Friday, February 27, 2015
Editor’s Note: The following post is based on a recent article earlier issued as a working paper of the Harvard Law School Program on Corporate Governance, by Leo Strine, Chief Justice of the Delaware Supreme Court and a Senior Fellow of the Program, and Nicholas Walter, associate in the litigation department at Wachtell, Lipton, Rosen & Katz. The article, Originalist or Original: The Difficulties of Reconciling Citizens United with Corporate Law History, is available here. Related research from the authors includes Conservative Collision Course?: The Tension between Conservative Corporate Law Theory and Citizens United, discussed on the Forum here. Research from the Program on Corporate Governance about corporate political spending includes Shining Light on Corporate Political Spending by Lucian Bebchuk and Robert Jackson, discussed on the Forum here, Corporate Political Speech: Who Decides? by Lucian Bebchuk and Robert Jackson, available here. and Conservative Collision Course?: The Tension between Conservative Corporate Law Theory and Citizens United by Leo Strine and Nicholas Walter, discussed on the Forum here.

Citizens United has been the subject of a great deal of commentary, but one important aspect of the decision that has not been explored in detail is the historical basis for Justice Scalia’s claims in his concurring opinion that the majority holding is consistent with originalism. In this article, we engage in a deep inquiry into the historical understanding of the rights of the business corporation as of 1791 and 1868—two periods relevant to an originalist analysis of the First Amendment. Based on the historical record, Citizens United is far more original than originalist, and if the decision is to be justified, it has to be on jurisprudential grounds originalists traditionally disclaim as illegitimate. The article is available on SSRN at http://ssrn.com/abstract=2564708.

Citizens United v. FEC struck down McCain-Feingold’s restraints on electoral expenditures by corporations. In his concurring opinion, Justice Scalia argued that the decision could be justified through the originalist approach to constitutional interpretation. In particular, Justice Scalia asserted that there was “no evidence” that, at the time of the Founding, corporations were not subject to government regulation of their ability to spend money to advocate the election or defeat of political candidates.

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2015 Benchmark US Proxy Voting Policies FAQ

By Harvard Law School Forum on Corporate Governance and Financial Regulation | Published Thursday, February 26, 2015
Editor’s Note: Carol Bowie is Head of Americas Research at Institutional Shareholder Services Inc. (ISS). The following post relates to ISS’ 2015 Benchmark Proxy Voting Policies.

ISS is providing answers to frequently asked questions with regard to select policies and topics of interest for 2015:

Proxy Access Proposals

1. How will ISS recommend on proxy access proposals?

Drawing on the U.S. Securities and Exchange Commission’s (SEC) decades-long effort to draft a market-wide rule allowing investors to place director nominees on corporate ballots, and reflecting feedback from a broad range of institutional investors and their portfolio companies, ISS is updating its policy on proxy access to generally align with the SEC’s formulation.

Old Recommendation: ISS supports proxy access as an important shareholder right, one that is complementary to other best-practice corporate governance features. However, in the absence of a uniform standard, proposals to enact proxy access may vary widely; as such, ISS is not setting forth specific parameters at this time and will take a case-by-case approach when evaluating these proposals.

Vote case-by-case on proposals to enact proxy access, taking into account, among other factors:

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Does Short Selling Discipline Earnings Manipulation?

By Harvard Law School Forum on Corporate Governance and Financial Regulation | Published Thursday, February 26, 2015
Editor’s Note: The following post comes to us from Massimo Massa, Professor of Finance at INSEAD; Bohui Zhang of UNSW Business School, and Hong Zhang of the PBC School of Finance, Tsinghua University.

The experience of the recent financial crisis has brought to the attention the role of short selling. Short selling has been identified as a factor that contributes to market informational efficiency. At the same time, however, short selling has been regarded as “dangerous” to the stability of the financial markets and has been banned in many countries. Interestingly, these two seemingly conflicting views are based on the same traditional wisdom that short selling affects only the way in which information is incorporated into market prices by making the market reaction either more effective or overly sensitive to existing information but does not affect the behavior of firm managers, who may shape, if not generate, information in the first place.

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