Broc Romanek is Editor of CorporateAffairs.tv, TheCorporateCounsel.net, CompensationStandards.com & DealLawyers.com. He also serves as Editor for these print newsletters: Deal Lawyers; Compensation Standards & the Corporate Governance Advisor. He is Commissioner of TheCorporateCounsel.net's "Blue Justice League" & curator of its "Deal Cube Museum."
The recent market crash has knocked quite a few companies out of WKSI status and some might not recognize the implications. In this podcast, Stephen Quinlivan of Leonard, Street and Deinard discusses the impact of the market drop on WKSI issuers, including:
– How has the recent market drop impacted some WKSI issuers?
– What are the implications of no longer being classified as a WKSI?
– Is there anything an issuer can do about it?
– What is the effect on registration statements of other issuers?
– Any other effects of the market drop?
CII’s New Policies: Gross-Ups, Severance Pay and More
During last week’s Council of Institutional Investors meeting, seven new corporate governance policies were adopted, including these four:
– Gross-ups: “Senior executives should not receive gross-ups beyond those provided to all the company’s employees.”
– Severance Pay: “Executives should not be entitled to severance payments in the event of termination for poor performance, resignation under pressure, or failure to renew an employment contract. Company payments awarded upon death or disability should be limited to compensation already earned or vested.”
– Proxy Solicitation: “Advance notice bylaws, holding requirements, disclosure rules, and any other company imposed regulations on the ability of shareowners to solicit proxies beyond those required by law should not be so onerous as to deny sufficient time or otherwise make it impractical for shareowners to submit nominations or proposals and distribute supporting proxy materials.”
– Executive Stock Sales: “Executive should be required to sell stock through pre-announced 10b5-1 program sales or by providing a minimum 30-da7 advance notice of any stock sales. 10b5-1 program adoptions, amendments, terminations and transactions should be disclosed immediately, and boards of companies using 10b5-1 plans should: (1) adopt policies covering plan practices; (2) periodically monitor plan transactions; and (3) ensure that company policies discuss plan use in the context of guidelines or requirements on equity hedging, holding and ownership.”
The other three polices relate to timely disclosure of voting results, shareholder rights to call special meetings and independence of accounting/auditing standard setters.
Delaware Court of Chancery Directs Hexion/Huntsman Merger To Go Forward
From Travis Laster, as posted on the DealLawyers.com Blog recently (here are the firm memos on the opinion): A few weeks ago, Delaware Vice Chancellor Lamb issued his much anticipated post-trial decision on the Hexion/Huntsman deal. In the opinion and implementing order, Vice Chancellor Lamb holds that (i) Huntsman had not suffered an MAE, (ii) Hexion “knowingly and intentionally” breached its obligations under the merger agreement such that potential damages are not limited to the $325 million termination fee, (iii) whether or not the combined entity would be insolvent is an issue that is not yet ripe, and (iv) Hexion must specifically perform its obligations under the merger agreement (which does not include an obligation to close). This decision is a blockbuster that will occupy center stage for a while. Here are some highlights from this major ruling.
Practitioners should start with the implementing order. It is a partial final order that Vice Chancellor Lamb certified as final pursuant to Court of Chancery Rule 54(b), thereby setting up an appeal as of right for Hexion.
Several paragraphs leap out of the order. In paragraphs 3-7, Vice Chancellor Lamb orders Hexion to move forward with the actions necessary to complete the merger. This is the type of open-ended, affirmative relief that Delaware courts often resist giving. Even more strikingly, in paragraph 8, Vice Chancellor Lamb prohibits Hexion from terminating the merger, and in paragraph 11, Vice Chancellor Lamb orders that “If the Closing has not occurred by October 1, 2008, the Termination Date under the Merger shall be and is hereby extended until five (5) business days following such date that this Court determines that Hexion has fully complied with the terms of this Order.” This language would appear to eliminate the drop dead date and make the Merger Agreement effectively open-ended, requiring Huntsman consent or court approval to terminate the deal. To my knowledge, this is unprecedented relief.
Turning to the opinion, VC Lamb first holds that there was no MAE. This is largely a fact-driven application of IBP and Frontier Oil; however, three points are particularly noteworthy. First, the Huntsman MAE contained a carveout for industry-wide effects, with an exception for effects with a disproportionate effect on HUN. Hexion argued that this required comparing Huntsman’s performance against the chemical industry’s performance to determine whether an MAE had occurred. VC Lamb rejects this reading and holds squarely that the initial inquiry is whether the target suffered an MAE at all. “If a catastrophe were to befall the chemical industry and cause a material adverse effect in Huntsman’s business, the carve-outs would prevent this from qualifying as an MAE under the Agreement. But the converse is not true–Huntsman’s performance being disproportionately worse than the chemical industry in general does not, in itself, constitute an MAE.” (37-38). This interpretive approach should apply to MAE carveouts generally and will affect how they are read and the leverage respective parties have.
Second, addressing the expected future performance of Huntsman, VC Lamb holds that whether Huntsman suffered an MAE is NOT measured by how it performed versus its projections. This is principally because in the merger agreement, Hexion disclaimed reliance on any Huntsman projections. “Hexion agreed that the contract contained no representation or warranty with respect to Huntsman’s forecasts. To now allow the MAE analysis to hinge on Huntsman’s failure to hit its forecast targets during the period leading up to closing would eviscerate, if not render altogether void, the meaning of [that section].” (46).
Third, in assessing the past performance aspect of the claimed MAE, VC Lamb concurred with Huntsman’s expert that the terms “‘financial condition, business or results of operations’ are terms of art, to be understood within reference to their meaning in Reg S-X and Item 7, the ‘Management’s Discussion and Analysis of Financial Conditions and Results of Operation’ section” of SEC filings. That section requires companies to disclose their results for the reporting period as well as their results for the same time period in each of the previous two years. Therefore, VC Lamb, holds that the proper benchmark for assessing whether changes in a company’s performance amount to an MAE is an examination of “each year and quarter and compare it to the prior year’s equivalent period.” (47-48) Though it addresses only one aspect of the MAE analysis-i.e. past performance not expected future performance-this is the clearest guidance the Court of Chancery has yet provided on the appropriate metrics for evaluating an MAE.
As in IBP and Frontier, burden of proof appears to have played a significant role in the ruling, and VC Lamb suggests in a footnote that parties to a merger agreement contractually allocate the burden of proof for establishing an MAE. (41 n.60).
In the next major ruling in the opinion, VC Lamb holds that Hexion committed a “knowing and intentional breach” of its obligations under the merger agreement. Hexion argued that the phrase “knowing and intentional” requires that a party (i) know of its actions, (ii) know that they breached the contract, and (iii) intend for them to breach of contract. (57). VC Lamb rejects this view as “simply wrong.” (57). He rather holds that a “knowing and intentional” breach is “a deliberate one — a breach that is a direct consequence of a deliberate act undertaken by the breaching party, rather than one which results indirectly, or as a result of the breaching party’s negligence or unforeseeable misadventure.” (59). It thus simply requires “a deliberate act, which act constitutes in and of itself a breach of the merger agreement, even if breaching was not the conscious object of the act.” (60).
Having interpreted “knowing and intentional breach” in this fashion, VC Lamb turns to Hexion’s actions over the past few months, during which Hexion identified a concern about the combined entity’s solvency, retained Duff & Phelps to analyze the issue, obtained an “insolvency” opinion, and then went public with its insolvency contentions and filed a lawsuit in Delaware. VC Lamb holds that this course of conduct breached (i) Hexion’s covenant to use its reasonable best efforts to consummate the financing and (ii) Hexion’s obligation to keep Huntsman informed about the status of the financing and to notify Huntsman if Hexion believed the financing was no longer available.
VC Lamb notes that “[s]ometime in May, Hexion apparently became concerned that the combined entity … would be insolvent.” (62). He remarks that a “reasonable response” at that time would have been to contact Huntsman and discuss the issue. But rather than doing that, Hexion hired counsel and began analyzing alternatives. At this stage, however, he observes that was not Hexion “definitively” in breach of its obligations. (63). But Hexion and its counsel then hired Duff & Phelps, which developed an insolvency analysis. At that point, “Hexion was … clearly obligated to approach Huntsman management to discuss the appropriate course to take to mitigate these concerns.” (63). Hexion’s failure to do so “alone would be sufficient to find that Hexion had knowingly and intentionally breached.” (64). Rather than doing so, Hexion obtained an insolvency opinion from Duff & Phelps and delivered it to the banks, which VC Lamb regarded as a clear, knowing and intentional breach. (67-68).
Vice Chancellor Lamb then wraps up by writing that “In the face of this overwhelming evidence, it is the court’s firm conclusion that by June 19, 2008 Hexion had knowingly and intentionally breached its covenants and obligations under the merger agreement.” (77). He holds that if it is later necessary to determine damages, “any damages which were proximately caused by that knowing and intentional breach will be uncapped and determined on the basis of standard contract damages or any special provision in the merger agreement.” (77). The merger agreement in fact contains a provision contemplating damages based on the lost value of the merger for stockholders. VC Lamb also rules that Hexion will have the burden to prove that any damages were not caused by its knowing and intentional breach.
After addressing two major issues, VC Lamb declines to make any ruling on the solvency of the combined entity, which was the issue that consumed the bulk of the parties’ litigation efforts at trial. VC Lamb holds that the question of the solvency of the combined company is not ripe “because that issue will not arise unless and until a solvency opinion is delivered to the lending banks and those banks either fund or refuse to fund the transaction.” (78). He notes that solvency of the combined entity “is not a condition precedent to Hexion’s obligations under the merger agreement,” and the lack of a solvency opinion “does not negate [Hexion’s] obligation to close.” (79). The issue is only relevant to the obligation of the lending banks. (79). He therefore leaves it for another day.
Finally, VC Lamb holds that Hexion must specifically perform its obligations under the merger agreement, while noting that the merger agreement specifically exempts Hexion from having the obligated to close. He finds the specific performance provision of the merger agreement to be “virtually impenetrable” and ambiguous, and he therefore resorts to extrinsic evidence, including the testimony of Hexion’s counsel, to interpret its meaning. He concludes that the Court can require Hexion to comply with all of its obligations short of consummation, but cannot order Hexion to consummate. “[I]f all other conditions precedent to closing are met, Hexion will remain free to choose to refuse to close. Of course, if Hexion’s refusal to close results in a breach of contract, it will remain liable to Huntsman in damages.” (87).
The Hexion decision joins IBP and Frontier as the major guideposts for MAE analysis. Hexion applies and elaborates on IBP and Frontier; it does not appear to open up any inconsistencies in Delaware’s approach. The opinion rather tends towards greater clarity in MAE application by establishing a rubric for interpreting carveouts, putting projections off limits when reliance on them has been disclaimed, and establishing a securities law-based standard for evaluating past performance. It is not readily apparent to me what the long-term impact of this greater clarity will be. Some MAE threats will likely not be made and others may be more readily rejected. But since part of the leverage to recut deals and resolve MAE issues flows from uncertainty over how the MAE issues will play out, the existence of more defined judicial standards could result in parties being more aggressive in their MAE positions and less willing to compromise. This ironically could lead to more MAE litigation.
The Hexion opinion is also a reminder of the importance Delaware places on contracts and contractual obligations. Both the URI decision from December 2007 and the Hexion ruling provide examples of Delaware courts enforcing bargained-for contractual provisions. In URI, those provisions favored the acquiror. In Hexion, they favored the target.
Last week, the SEC Staff posted a 129-page Enforcement Manual. I believe that this document is new and not something the Staff has been sitting on behind closed door – although I don’t think the content itself is anything new. It’s a great idea since it seems to pull together all of the key Enforcement positions and policies in one place. I’m not sure why the SEC made it public, but I’m glad they did.
Gibson Dunn has written this memo summarizing some of the key areas of the SEC’s Enforcement Manual, including waiver of privilege, document production and the process by which the Staff may contact employees of a company under investigation.
The RiskMetrics’ 2008 Postseason Report
RiskMetrics Group has released its 2008 Postseason Report (and a series of unique industry sector reports). We have posted an executive summary of the Postseason Report in our “Proxy Season” Practice Area. Some key takeaways from the report include:
-Board declassification proposals received the greatest backing this year, averaging 67% support at 76 firms, up from 64% in 2007.
-Proposals calling for an independent board chair saw average support climb by more than 5% to nearly 30% of votes cast “for” and “against.”
-While the global credit crisis resulted in fewer transactions this year, hedge funds and other activists continue to target underperforming companies, leading to another record year for U.S. proxy contests.
-While most directors were elected with broad support, investors have become increasingly willing to withhold support from board members in uncontested elections, even in the absence of a high-profile “vote no” campaign. In fact, directors at 82 S&P 500 companies received more than 10% opposition this year, up from 64 firms in 2007 and 57 in 2006.
How to Change Your Advance Notice Bylaws
We have posted the transcript from the popular webcast: “How to Change Your Advance Notice Bylaws.”
It looks like the folks at AIG have taken “tone at the top” to heart. Unfortunately, their tone isn’t of the type that is good news for taxpayers, who now own 80% of AIG. As this Washington Post article describes, two former AIG CEOs were grilled during a House Committee on Oversight and Government Reform hearing this week (one of whom received a $5 million performance bonus just before he left – in addition to a $15 million golden parachute – and another AIG executive was fired who still receives $1 million per month for consulting services). The former CEOs expressed no remorse for their actions that drove AIG into the arms of the government and didn’t acknowledge making any mistakes. Rather, they blamed the accounting. The House committee members were visibly disturbed by the sheer audacity of these so-called corporate leaders. Given the long list of troubling practices at AIG described in this front-page WSJ article, we may well see these two in pinstripes someday.
The topper is the fact that AIG is now getting an additional $37.8 billion loan from the taxpayers, which is lumped on top of the $80 billion load the government provided last month. This came a day after it was revealed that the company held a junket for sales reps at a resort, spending unbelievable amounts of the taxpayer’s money. How exactly does one spend $23,000 on spa treatments or $5,000 at the bar? The story is outrageous and listening to the radio, it’s fair to say that AIG already has become the posterchild of all that is broken in Corporate America. If this doesn’t get you mad, nothing will.
Reflecting on a True Corporate Leader
Kevin LaCroix does a masterful job reviewing the new uncensored – and authorized – biography of Warren Buffett in his “The D&O Diary Blog. In my opinion, Warren is one of the few leaders in Corporate America deserving of the title “leader.” Reading Kevin’s description, you can see that Warren values his reputation more than money. How many CEOs can you say that about?
It’s worth noting that Warren’s annual letter to shareholders is one of the only “straight talk” pieces out there when it comes to disclosure documents for shareholders. I’ve never understood why other CEOs haven’t followed his lead. Just like few have followed his lead in the face of today’s crisis to speak up, take actions to show they are accountable and try to produce calm.
So What Now? Does Board-Centric Oversight Really Work?
Given the events leading up to this crisis (and continuing today, see the AIG story above), there certainly will be a rash of regulatory reforms. It’s clear that there are numerous practices that need fixing and right now, Corporate America doesn’t seem capable of doing it on its own.
Exhibit A is excessive executive compensation. As I often state when debating defenders of today’s pay packages, would you be motivated to work to 100% of your abilities if you made $10 million per year? If the answer is “yes,” what purpose does paying you $20 million serve?
Apologists then trot out the argument that another company may pay you that $20 million – thus, your current employer should pony up. That may well be true in relatively rare circumstances – but the reality is that there are very few CEO superstars that could easily move from one company to another (just like there are few superstars in sports that could command top dollar from another team).
Boards continue the status quo of handing out oversized pay packages because it’s the easy thing to do. Having that hard negotiation with a sitting CEO is tough to do – most directors have day jobs where they face tough situations every day and I imagine that it would be rough to go to a board meeting and continue fighting the good fight. But that is their job and they need to do it – or they need to drop off the board. As I blogged recently, I hear that the few companies that really make responsible changes are the ones where the CEO speaks up and voluntarily asks for the change. Sadly, boards and compensation committees are not the ones driving responsible change.
In the wake of the ongoing crisis, there may well be a push to dramatically alter the board-centric oversight model that exists today. In his most recent column, Jim Kristie of “Directors and Boards” looks at this topic, first noting Marty Lipton’s speech defending the board-centric model from a few months ago, then pointing out that growing evidence of a lack of confidence in the board-centric model today and ending with the thought that “shareholder-centric governance may be one of the ways out of this financial crisis, widely thought to be the worst since the Great Depression.”
Powerful food for thought. Are boards listening – and acting – to stave off this possibility? Like most others, I’m cynical at this point. My guess is that most would rather blame the accounting or short sellers than take responsiblity for their own oversight failures. True leadership is a rare commodity these days.
The Bottom Line: We Need Trust
I believe the reason that the government’s daily solutions to the credit crunch are not working is because the trust within our system has evaporated. It is widely reported that banks refuse to lend to each other. The approval rating of our politicians are at historical lows.
And I wouldn’t be surprised if many of the retail investors now leaving the stock market never return, particularly the older baby boomers who don’t have the time to wait this out. And even though our markets are now dominated by institutional investors, their size often is attributable to participation by the masses. Look for their sizes to shrink as coffee cans are buried in the backyard. Without true leadership – setting the proper tone at the top and taking responsibility – I don’t think this market will turn around. To start down the path to true leadership, CEOs can start by voluntarily reining in their excessive pay packages.
With many law firms suffering from a dearth of transactional work – compounded by the biggest market crisis of our generation – the sheer number of firm memos being produced has been overwhelming lately. Here is where we have been posting the hordes of memos related to the crisis:
Work on Congressional Fair Value Study Commences: Comments Solicited
The SEC has commenced its study on “mark-to-market” accounting – and is authorized by Section 133 of the Emergency Economic Stabilization Act – and is soliciting comment. The Act requires the study to be completed by January 2nd and the SEC must consult with Treasury and the Federal Reserve. Notably, the IASB announced that it believes last week’s SEC-FASB clarification on fair value is consistent with IAS 39.
Last month, Corp Fin Director John White and Deputy Chief Accountant James Kroeker (who is heading up the SEC’s study now) gave this testimony on transparency in accounting before the Senate Banking Committee.
A few weeks ago, I blogged about the SEC’s new “21st Century Disclosure Initiative,” including a summary of a proposal from Joe Grundfest and Alan Beller – as well as my ten cents on the entire idea. Today, the SEC is holding a roundtable on the idea – and has posted these FAQs and this strategic plan.
Trotting this new initiative out now seems like a bad idea when it won’t really bear on any of the problems associated with the current credit crisis. Bizarrely, the SEC issued this press release yesterday that revised the title of this roundtable so it’s framed as if it’s dealing with transparency in the credit crisis (here is the original press release).
At least, this illustrates that the SEC understands the need to tackle the credit crisis topic – unfortunately though, this roundtable isn’t about it. During the roundtable, if one was to hold a drinking game with “credit crunch” as the trigger term, I fear there wouldn’t be much action outside of the Chairman’s opening remarks. This perceived inaction by the SEC in the face of a major crisis will continue to provide fodder for folks like those over at “The Conglomerate” blog, which recently wrote a daily list of regulatory actions to combat the crisis – with the SEC penciled in as “The SEC did nothing.” The SEC should be in crisis mode and setting aside any unrelated projects.
– Is This Project Dealing with “Form over Substance”? – When I read the SEC’s strategic plan, I was disappointed that the direction of the initiative clearly seems to be in the vein of “form over substance.” The SEC’s vision of this project seems to consist of creating a “Company File System,” where all the core information about a company would be in a centrally and logically organized interactive data file. When you read that description, a fair question might be: “Isn’t that what Edgar does today?” And a straight-faced answer would be: “For the most part, yes.”
As I mentioned in my last ten cents on this topic, I believe the SEC should be focused more on updating its substantive requirements – without that kind of meat involved in this project, I find the phrase “21st Century Disclosure Initiative” to be undeserving. This rulemaking simply doesn’t carry that kind of importance and it’s misleading.
Nothing personal about Bill Lutz (who is leading this initiative), but as his biography shows, he is an English Professor – and that’s not the best background to lead us down the path to better substantive requirements. At this point, this is Chairman Cox’s baby and I don’t feel a heavy Corp Fin presence in this project – and it’s supposed to be about disclosure.
– Why a “Hash Mark System” Might Not Work – Putting aside my reservations about the timing of this initiative, I do have some thoughts about a “Company File System.” I think it’s important for companies to be required to file their core information – whatever the format (ie. HTML, XBRL) – on a single government site that is common for all reporting companies, like EDGAR is today. It’s very efficient to be able to go directly to one site and type in the name or trading symbol of a company and go directly to a company’s filings.
One of the ideas being considered is that companies would fill out online questionnaires and then they wouldn’t file their questionnaire responses directly with the SEC – rather they would post the responses on their own websites, with a ‘hash’ that authenticates the document as well as the date and time of posting. I have three concerns regarding this idea:
1. Challenges of Maintaining Content – I think this “hash mark” idea may be challenging for companies to implement. They would be required to ensure that those links stay active. You would think that this would be easy to accomplish, but I find that companies change the URLs of their IR web pages much more frequently than you would think. (I know this because I try to maintain a list of links to the IR web pages of widely-held companies and it requires constant updating).
2. Security Considerations – Another consideration for companies is the fear that the “official” documents now required to be on their servers would get hacked.
3. Investor Trust – Finally, and most importantly, investor studies show that investors trust documents filed – and found – on a government website more than documents found on a company’s site. Rightfully so, investors tend to view documents posted on corporate websites as marketing material.
The SEC: Under Fire
Even before Senator McCain was calling for SEC Chairman Cox to be fired, the SEC has been under attack. The latest is a claim that the SEC censored a report to hide its role in the Bear Stearns implosion. According to this Bloomberg article, the SEC’s Inspector General released a report a few weeks ago that “deleted 136 references, many detailing SEC memos, meetings or comments, at the request of the agency’s Division of Trading and Markets that oversees investment banks” (the SEC’s IG also released this companion report regarding the SEC’s broker-dealer risk assessment program). An unedited version of this report is posted on Senator Grassley’s website.
The SEC’s Inspector General has issued another report – also requested by Senator Grassley (see his letter from yesterday) – regarding the 2005 firing of Gary Aguirre, an SEC lawyer who claimed superiors impeded his inquiry into insider trading at hedge fund Pequot Capital Management. This report was released by the Senate Finance Committee yesterday, but is not yet posted on the SEC’s website – the articles states that the report “said the agency should consider punishing the director of enforcement and two supervisors over the firing.”
Perhaps in response to the pressure, Chairman Cox hired a former head of the Congressional Budget Office as a senior adviser yesterday – and according to this article, recently hired two new public relations officers.
Treasury Department: Implementing TARP ASAP
As required by the Emergency Economic Stabilization Act, the Treasury Department is moving quickly to choose advisers, issue regulations, and hire companies to serve as asset managers for its “Troubled Asset Relief Program” (known as “TARP”).
The first big move by Treasury was issuing a number of interim guidelines (egs. asset manager selection process; conflicts of interests) – as well as three “solicitations for financial agents,” which have a deadline for comments by 5:00 pm today.
Neel Kashkari – age 35! – has been named the interim head of the new Office of Financial Stability, which will implement the TARP (he was the Assistant Secretary for International Economics and Development and has been a key adviser to Hank Paulson). This office will hire a small staff with expertise in asset management, accounting and legal issues.
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More Companies Using Internal Pay Equity as Alternative Benchmarking
During our Conferences, some of the most respected compensation consultants will describe how companies can implement internal pay equity as an alternative to peer group benchmarking (see the Conferences’ agendas). With so much attention right now on excessive executive compensation, we predict that this methodology will really take off over the next year given how existing peer group surveys are comprised of inflated data.
Some companies have already taken the leap. In its 2008 proxy statement for Cerner Corporation, the company discloses that it uses internal pay equity guidelines that provide that its “CEO’s total cash compensation shall not be more than three times that of the next highest total cash compensation (the company’s board must approve any exception to these guidelines).”
My Ten Cents: Overcoming Objections to Internal Pay Equity
To the extent there is pushback from compensation consultants about clients using internal pay equity as an alternative benchmark to peer groups, I can understand it – because internal pay likely will reduce the level of the consultant’s role in the pay-setting process. With internal pay, consultants can advise clients about how to implement internal pay equity methodologies, but they wouldn’t make money for the use of their peer group database. This is because internal pay equity is an “internal look” at the company’s own pay scale.
But for the life of me, I can’t understand why lawyers would advise their clients not to consider internal pay equity. Over the past few years, peer group benchmarking has been criticized by many quarters. It’s not that peer group analysis is not useful per se, it’s just that the current batch of CEO pay data is tainted because most boards sought to pay their CEOs in the top quartile for 15 years – thus driving CEO pay inflation through the roof.
Given that most boards rely on peer group benchmarks as the paper trail to show that they were informed when exercising their fiduciary duties – and given that peer group benchmarking is now widely discredited – shouldn’t lawyers be advising boards to find another source of documentation for their files? Or urging them to obtain at least an additional layer of protection by balancing peer group benchmarking with internal pay equity?
The old adage that “everyone else is doing it” simply doesn’t work anymore with regulators and courts. Imagine a courtroom where several experts are brought in to show how peer group data is tainted and that everyone “should have known” it. It’s easy if you try…
Want to know how your future looks in the wake of the bailout legislation? Tune in tomorrow for this webcast – “Latest Developments in Capital Market Deals” – to hear how the markets are functioning right now and what the future holds. The panel includes both an equity and a debt banker, as well as legal experts from the East Coast, West Coast and the Midwest. The panelists include:
– Edward Best, Partner, Mayer Brown
– Michael Kaplan, Partner, Davis Polk & Wardwell
– J. Maurice Lopez, Managing Director, Citigroup Global Markets
– Patrick Schultheis, Partner, Wilson Sonsini Goodrich & Rosati
– Bill Schreier, Head of Equity Capital Markets, BM Capital Markets
Coming Soon? Code of Ethics for Proxy Advisory Services
For the past few months, Meagan Thompson-Mann, a visiting fellow at Yale’s Millstein Center for Corporate Governance and Performance, has been soliciting comment regarding voting integrity in the proxy voting process in response to a draft study she drafted. Among other things, her study suggests a code of ethics for proxy advisory services and includes a proposed code. It raises the possibility of sharing information with companies, but leaves it up to the advisor (p. 21) – and it also provides that a proxy advisor should not give companies any assurances of a particular recommendation prior to its release (p. 15). Weigh in with your thoughts if you can.
RiskMetrics Begins Advising on Tender Offers
As I noted recently on the DealLawyers.com blog, RiskMetrics’ ISS Division recently broke with tradition and advised its clients not to tender Longs Drug Stores’ shares into CVS’ tender offer. Historically, RiskMetrics has only made recommendations on shareholder votes and left tender offers alone. So changing the structure of a deal from a merger to a tender offer will no longer have the incidental effect of removing RiskMetrics from the equation…
We’ve posted a copy of the US Senate’s “agreement in principles” that was reached yesterday for the bailout legislation (this WSJ article analyzes the odds of passage – and Dominic Jones explains the importance of retail investors for passage). Here is the very first principle:
Requires Treasury Secretary to set standards to prevent excessive or inappropriate executive compensation for participating companies.
The notion that a group of government staffers may be setting the parameters for a number of CEO pay packages is nearly incomprehensible. I’m glad it isn’t me.
What are “Appropriate Standards” for “Shareholder Disclosure”?
From Will Anderson of Bracewell & Giuliani: The draft language in the Senate bill released earlier this week contains what I view as a potentially significant “sleeper” issue that seems to have escaped the attention of the media, commentators and the Congress (although I confess that I have had trouble keeping up with the flow of information). The Senate draft provides that the Treasury Secretary require sellers to meet “appropriate standards” for “shareholder disclosure.” The draft from the House Financial Services Committee includes the same requirement for “corporate governance”.
It’s not clear to me what the Senate’s “shareholder disclosure” requirement means, but it could be read to grant very broad and virtually unlimited authority to Treasury to establish a disclosure system for participating financial institutions. Or perhaps this language is limited to only executive compensation disclosure, although that is not what the language says. Or maybe it means something entirely different – one lawyer I spoke with thought it could be read to mean disclosure of the identity of the shareholders of financial institutions, but I doubt that is the intent (but who knows).
Hopefully, the shareholder disclosure language will simply be deleted from the bill that comes out over the next few days – or at least add a “related thereto” after the words “shareholder disclosure” so that it is limited to executive compensation. Perhaps the House has it right and it will be replaced with “corporate governance”, although that requirement presents a host of issues that are better left for another day. Here is the Senate’s most recent text (emphasis added):
SEC. 17. EXECUTIVE COMPENSATION.
The Secretary shall require that all entities seeking to sell assets through a program established under this Act meet appropriate standards for executive compensation and shareholder disclosure in order to be eligible, which standards shall include—
Here is the House Financial Services Committee’s most recent text (emphasis added):
SEC. 9. EXECUTIVE COMPENSATION AND CORPORATE GOVERNANCE.
(a) IN GENERAL.—The Secretary shall require that all financial institutions seeking to sell assets through the program under this Act meet appropriate standards for executive compensation and corporate governance in order to be eligible.
The Short-Sleeve Culture: Celebrating Twenty Years
Twenty years ago, fresh off the bar exam, I started my professional career as a junior lawyer in Corp Fin. Five other lawyers started that day with me, including Bill Tolbert, Mark Coller and Larry Spaccasi (folks like Marty Dunn, Scott Freed, Celia Spiritos and Todd Schiffman started a few weeks before). Back then, more lawyers were hired right out of school – rather than the laterals that get into the SEC today – so a new batch always started in the Fall.
After a half-day of fingerprinting and general orientation, my branch chief, Steve Duvall, handed me a set of CCH books (ie. the rules) and told me to read them. That was my task for the week – a straight read of the rules. Ken Tabach was riding out his last week on the Staff before splitting for a law firm and he gave me some loose guidance about how to read a registration statement and write up comments.
Those comments that passed muster were read over the phone to an outside lawyer, who taped them and had them transcribed into a comment letter (eventually, we had a SEC secretary type the letter too – but that would take weeks as six or seven lawyers shared each secretary).
There were no computers and no voicemail for the phones. People could smoke in their offices if so inclined – and the old-timers followed an informal policy that they could wear short-sleeves if it was hotter than 90 degrees. And there were government-sponsored keg parties – or is that my vivid imagination playing tricks on me? Right after I started, Market Reg sponsored a party at a local bar to note the one-year anniversary of the ’87 “market break” (that was a day when the market crashed at record levels for a day).
When I returned for my second tour of duty in Corp Fin years later, Bill, Mark and I would grab a morning donut together every year on this date to commemorate our anniversary. For those guys, I’m having two today…
With executive pay a key negotiation point in the bailout bill, rest assured that next year’s executive compensation disclosures will be more important than even. Last week, Mike Melbinger blogged three times about how the SEC Staff is now commenting on CD&A and other compensation disclosures as part of its Year Two review under the SEC’s new rules. Don’t forget that Corp Fin Director John White will serve as the keynote speaker for our upcoming “Tackling Your 2009 Compensation Disclosures: The 3rd Annual Proxy Disclosure Conference.” If you can’t make it to New Orleans on October 21st-22nd, you can still catch this important conference by video webcast.
Last Friday, as part of its temporary emergency actions, the SEC issued an emergency order temporarily suspending the timing restrictions and significantly increasing the volume limitation for issuer repurchases under Rule 10b-18. Since then, I’ve seen a few announcement of stock repurchase programs from companies of all shapes and sizes, including Microsoft ($40 billion) and 3Com ($100 million). The SEC’s order expires next Thursday.
South Dakota’s Short-Selling Ballot Initiative
Below is an excerpt from a Morrison & Foerster memo on short-selling:
Some contend that the SEC’s actions are too little, too late. This November, voters in South Dakota will consider a ballot initiative called Measure 9 that could impact short selling across the United States. Promoted by American Entrepreneurs for Securities Reform, or ESR, a non-profit organization backed by small businesses, Measure 9 would amend sections of the South Dakota Uniform Securities Act of 2002.
The initiative is cast by ESR as a consumer protection measure that will protect South Dakota’s small investors by curbing naked short selling. Opponents of Measure 9 argue that the initiative is unnecessary, impractical, poorly drafted and unconstitutional, with the potential to halt all legitimate short selling activity in the U.S.
Several commentators oppose Measure 9 on the grounds that, as written, the ballot measure would effectively ban short selling altogether. The proposed law would permit the state to take action against a seller of stock in a publicly traded company if that seller engaged in a pattern of commercially unreasonable delay in the delivery of securities sold, or “has sold securities that the person did not own or have a bona fide contract to purchase.” This language tracks the definition of a short sale in Regulation SHO. The law would apply to any brokerage registered in South Dakota even if it does not have an office there.
If interpreted to ban short sales altogether, a broker that transacts short sales with investors in South Dakota would violate the law, regardless of where the transaction takes place or whether the transaction takes place or whether the transaction complies with federal law. Because a broker-dealer’s South Dakota registration is all that would be required to trigger liability under the law, some have predicted that Measure 9 would result in broker-dealers leaving the state or, alternatively, ceasing all short selling activities.
ESR and its supporters contend that the SEC’s efforts to restrict naked shorting have been ineffective and support additional regulation at the state level. From their perspective, the purpose of Measure 9 is to ban naked short selling by permitting South Dakota regulators to take action against broker-dealers engaged in a pattern of fails-to-deliver. Opponents of Measure 9 argue that the trading of securities occurs on a national market and accordingly, should be regulated solely by federal law to preserve consistency, making additional state regulation both unnecessary and impractical.
They predict that the introduction of additional legislation in various states will result in a confusing patchwork of inconsistent and contradictory rules, choking the very markets they are designed to protect. Additionally, they contend that proposed law would be preempted by the National Securities Market Improvement Act (and thus would be unconstitutional). These opponents point out that litigation over the law after it has been adopted (on preemption grounds) would be costly and time-consuming for the parties opposing it, as well as for South Dakota taxpayers.
Conclusion
Measure 9 is not the first proposal of its kind. Measures seeking to limit shorting have popped up in other states such as Virginia and Arizona, where legislation was introduced and quickly withdrawn, and Utah, where such a measure was overturned. Despite setbacks for these similar proposals, ESR plans to lobby for similar legislation in 19 additional states. Opponents of Measure 9 are concerned that the initiative, which addresses relatively sophisticated matters of securities law, will pass due to a lack of voter understanding, leading to unintended consequences in the national markets. Even if Measure 9 is not approved by South Dakota voters or is subsequently overturned, it, and similar proposals, as well as continuing market pressures, will place additional pressure on the SEC to demonstrate that it is proactive in its efforts to curb abusive short-selling practices. The impact of the SEC’s newest regulations on shorting activities, legitimate or otherwise, and whether the results will satisfy activist groups like ESR remains to be seen.
Predictably, the bare-boned Treasury proposal for a bailout bill – fraught with Constitutional problems – is receiving backlash on the Hill. Also predictable – given that elections are coming up – many key Republicans have come around to the notion that the bailout bill should include limits on executive pay (see this Washington Post article and NY Times’ article).
However, the bailout plan is missing a strategy to fix the problems that caused all the problems that the market faces. Without a going-forward plan, I don’t see an end to shoveling money to the bailout. Simply banning short sales ain’t gonna do it. Yesterday, SEC Chairman Cox testified about some of these problems before the Senate Banking Committee – here is an excerpt:
The failure of the Gramm-Leach-Bliley Act to give regulatory authority over investment bank holding companies to any agency of government was, based on the experience of the last several months, a costly mistake. There is another similar regulatory hole that must be immediately addressed to avoid similar consequences. The $58 trillion notional market in credit default swaps – double the amount outstanding in 2006 – is regulated by no one. Neither the SEC nor any regulator has authority over the CDS market, even to require minimal disclosure to the market.
Economically, a CDS buyer is tantamount to a short seller of the bond underlying the CDS. Whereas a person who owns a bond profits when its issuer is in a position to repay the bond, a short seller profits when, among other things, the bond goes into default. Importantly, CDS buyers do not have to own the bond or other debt instrument upon which a CDS contract is based. This means CDS buyers can “naked short” the debt of companies without restriction. This potential for unfettered naked shorting and the lack of regulation in this market are cause for great concern. As the Congress considers fundamental reform of the financial system, I urge you to provide in statute the authority to regulate these products to enhance investor protection and ensure the operation of fair and orderly markets.
What Companies are Disclosing: Form 8-Ks Filed in Response to the Crisis
With the market in crisis, it would be expected that some companies would be be filing Form 8-Ks to disclose material developments. Here are just a few of the many Form 8-Ks filed regarding potential fallout due to exposure from Lehman Brothers and/or AIG:
I need to ask you to support an urgent secret business relationship with a transfer of funds of great magnitude.
I am Ministry of the Treasury of the Republic of America. My country has had crisis that has caused the need for large transfer of funds of 800 billion dollars US. If you would assist me in this transfer, it would be most profitable to you.
I am working with Mr. Phil Gram, lobbyist for UBS, who will be my replacement as Ministry of the Treasury in January. As a Senator, you may know him as the leader of the American banking deregulation movement in the 1990s. This transactin is 100% safe.
This is a matter of great urgency. We need a blank check. We need the funds as quickly as possible. We cannot directly transfer these funds in the names of our close friends because we are constantly under surveillance. My family lawyer advised me that I should look for a reliable and trustworthy person who will act as a next of kin so the funds can be transferred.
Please reply with all of your bank account, IRA and college fund account numbers and those of your children and grandchildren to wallstreetbailout@treasury.gov so that we may transfer your commission for this transaction. After I receive that information, I will respond with detailed information about safeguards that will be used to protect the funds.
