In this past Sunday’s NY Times, an economist – Robert Frank – wrote an essay about whether Congress should limit executive pay. Although Frank makes some accurate observations, the piece is typical of most written by academics and others who are not familiar with the processes by which executive pay is set (Frank’s lack of knowledge is evident when he states that “salaries” drive job choices – not true since salaries are just a nominal part of CEO pay packages, at least at larger companies). Frank cites the two primary reasons for heightened pay over the past few decades is that market caps for companies have grown and that executives are more likely to change jobs these days.
Although I agree that those two factors have contributed to escalating pay, they are not the major factors. As I wrote several years ago in my “Open Letter to All Journalists,” you need to understand what is happening in the boardroom – particularly compensation committee meetings – to really understand why executive pay has risen. It’s these board processes (eg. peer group benchmarking; severance/COC arrangements because “everyone else is doing it”; annual option mega-grants) that continue to be broken and have inadvertently led to excessive pay. Fixing these processes is critical, including the very difficult task of unwinding past arrangements.
I continue to contend that Congress shouldn’t force boards to fix their processes – boards should be doing that themselves. But if boards don’t soon – and they sure have been slow to figure out their role in fixing the problems of executive pay – it seems inevitable that Congress will act.
And unfortunately, I believe any new Congressional action won’t solve our pay problems because boards (with the help – and even prodding – of errant advisors who forget their represent the company, not the top managers) always seem to find a way around artifical limits, thereby “creating” unintended consequences.
Boards must be accountable and need to take a leadership role here. I remain stunned as most boards still don’t seem to have figured this all out yet…as I’ve blogged before, the few companies taking responsible pay actions appear to have the CEO leading the charge rather than the directors.
“Say-on-Pay” in Action: 38% Vote “No” at Jackson-Hewitt’s Annual Meeting
To get a window on what may happen if say-on-pay legislation is enacted in the US, look no further to the results from the recent annual shareholder meeting for Jackson-Hewitt Tax Services. As noted in the company’s Form 10-Q filed last month, 37.5% of the votes cast were voted against the company’s pay package (see Proposal III) – the highest level of opposition so far for an advisory vote in the U.S. market. This is only the fifth company in the US to allow say-on-pay on the ballot – once more companies allow it, I imagine the levels of opposition will grow given the environment out there today.
Congrats to Dave for getting quoted in this front-page article recently in the Washington Post. The article is entitled “Executive Pay Limits May Prove Toothless.” And more importantly, the article mentions our new treatise! I find it hard to believe, but someone told me they heard Alex Bennett review the treatise during his Sirius radio show…
“Say on Pay” and Preliminary Proxy Statements
Brink Dickerson of Troutman Sanders reports that a preliminary filing of a proxy statement under Rule 14a-6(a) is required in connection with management say-on-pay proposals. While Rule 14a-6(a)(4) eliminates the filing requirement for the “approval or ratification of a [compensation] plan…or amendment to such plan,” Interpretation N.10 from the Manual of Publicly Available Telephone Interpretations makes it clear that this is a narrow exclusion and does not apply to after-the-fact approval of specific compensation (note that this set of interps may be updated any day now, per statements of Corp Fin Staff). In addition, the Corp Fin Staff confirmed for one of Brink’s colleagues that a management say-on-pay proposal would not fall within the Rule 14a-6(a)(4) exception.
A number of the companies with management say-on-pay proposals (egs. AFLAC, Littlefield and H&R Block) have filed preliminary proxy statements, but they had other proposals that would have triggered a preliminary filing in any event. Other companies appear to have overlooked this requirement.
Below is a response that I received from a member in response when this same blurb from Brink was posted a few days ago on “The Advisors’ Blog“: Whether right or wrong, I believe common practice is that companies do not file preliminary proxy statements even when awards to employees are made subject to the approval by shareholders of a new plan or an amendment to an existing plan. And don’t forget this additional important nuance from NYSE and Nasdaq FAQs on Equity Compensation Plans – here is NYSE FAQ F-2 (2/18/04):
If shareholder approval of a new equity compensation plan is required, may grants be made before the approval is obtained, so long as the grants are forfeited if the shareholder approval is not in fact obtained?
No shares may be issued until the approval is obtained. This is because the Exchange requires that a supplemental listing application (“SLAP”) be filed before the shares are issued, and the SLAP will not be accepted unless any required shareholder approval has already been obtained. Grants may be made before shareholder approval, provided that no shares can actually be issued pursuant to the grants until it is obtained. For example, a listed company could grant stock options that would not become exercisable until after shareholder approval is obtained. On the other hand, restricted stock could not be issued before shareholder approval, because restricted stock is issued upon grant. Note, however, that the company could promise to issue restricted stock at a future date after shareholder approval is obtained.
Catch Alan in his popular annual webcast “Alan Dye on the Latest Section 16 Developments” to hear all the latest developments you need to know. As all Section16.net memberships are on a calendar-year basis, renew for ’09 now.
Study Finds Emergency Short-Selling Restrictions Had No Impact
Linda DeMelis notes: According to a recent study, the emergency restrictions on short selling imposed by the US, the UK and other European countries last fall had no significant impact on stock price behavior. Their research suggests that the restrictions were not effective in reducing the probability of large stock price drops, which was a principal reason the restrictions were imposed.
There has been scant research published on the impact of the hurriedly-imposed short-selling restrictions. Once the new Obama Administration gets going, I suspect we are going to see a lot of proposals to reform various regulations, including the short-sale rules, and studies like this are going to get more attention. We have posted the study in our “Short Sales” Practice Area.
How to Issue FDIC-Guaranteed Debt under the TLGP
We have posted the transcript from our popular webcast: “How to Issue FDIC-Guaranteed Debt under the TLGP.”
Delaware Chancellor Weighs in on Drafting LLC Agreements
Given the increasing popularity of limited liability companies and the ability of parties to define the scope of fiduciary duties in the governing agreements of these entities, the attached decision by Chancellor Chandler recently in Kahn v. Portnoy (C.A. No. 3515-CC) denying a motion to dismiss a breach of fiduciary action involving an LLC dispute warrants noting and review – particularly for people involved in the drafting of LLC agreements.
The plaintiff, a shareholder of TravelCenters of America, LLC, alleged that the director defendants of TA breached their fiduciary duties by approving a self-dealing transaction allegedly designed to benefit a TA director at the expense of the company. Given TA’s status as an LLC, the fiduciary duties of TA’s directors are interpreted by reference to the entity’s LLC agreement. As explained by the Chancellor, “[t]he well settled policy of the Delaware Limited Liability Company Act is to give maximum effect to the principle of freedom of contract” and “all fiduciary duties, except the implied contractual covenant of good faith and fair dealing, can be waived in an LLC Agreement.”
The terms of TA’s governing LLC agreement provided that the “‘authority, powers, functions and duties (including fiduciary duties)’ of the board of directors will be identical to those of a board of directors of a business corporation organized under the . . . DGCL, unless otherwise specifically provided for in the LLC Agreement.” Another section of the Agreement (Section 7.5(a)) dealt specifically with conflict of interest transactions and provided, among other things, that a challenger of board action “shall have the burden of overcoming [a presumption that the board acted properly and in accordance with its duties (including fiduciary duties)] by clear and convincing evidence.”
While the allegations in the complaint were sufficient to state a claim under general Delaware fiduciary duty case law, defendants argued that Section 7.5(a) of the Agreement altered the applicable pleading standard and mandated dismissal. The Court disagreed, finding that, at the pleading stage, the above language was arguably limited by preceding language in the Agreement suggesting that the clause “would only create a presumption for transactions in which there is a conflict between a shareholder and the board or a shareholder and the Company, but not where there is a conflict between a director and the company.” The Chancellor accordingly denied defendants’ motion to dismiss given that he only needed to “determine whether plaintiff would be entitled to relief under any reasonable interpretation of the facts alleged” and not by “apply[ing] a standard of proof” at the pleading stage.
Portnoy therefore illustrates the importance of clear language in contractual limitations of fiduciary duties in LLC agreements and provides insight into the manner in which courts analyze these provisions. Indeed, the founders (and directors) of TA most likely intended – and believed – that the above quoted language protected the directors in all conflict of interest transactions. The Court did not necessarily disagree; rather, it merely found that the above ambiguity gave way to more than one reasonable interpretation and thus precluded dismissal. As a result, the litigation will proceed to discovery before the defendants will again have the opportunity of attempting to reap the benefits of the above provision. The decision thus warrants careful review by practitioners drafting (or litigating) such provisions.
Also note that the opinion contains helpful primers on a multitude of other corporate fiduciary concepts, including succinct summaries on the meaning of “good faith” (See Op. at 18) and the concepts of “independence” and “disinterestedness” for purposes of demand futility (See Op. at 26).
In today’s Washington Post, Steven Pearlstein writes a column arguing that Mary Schapiro would be a great choice as SEC Chair at any other time but now. I often agree with Pearlstein’s thoughts, but I contend that Mary indeed is a great choice – and now is the most when we need someone with her incredible experience and willingness to act independently. Here are a few specific points:
1. Experience to Spare – No one can come close to Mary’s experience – a SEC Commissioner at a young age when most lawyers are still learning the rudimentary basics; a former Chair of the CFTC (an agency with a different culture and mission, which may soon be merged with the SEC) and in leadership positions at FINRA (and its predecessor, the NASD) for the past decade. She is the best person to parse the issues related to reforming the derivative disaster, which is some complicated stuff. And if I remember correctly, she was appointed to the Commission back in 1988 as an “Independent,” long before that became fashionable. I dare say there has never been anyone with this breadth of experience…ever.
2. Need Level-Headed Drastic Measures – I agree with Pearlstein that drastic measures have to be taken to shake up Wall Street culture. As Pearlstein admits, Mary is a reformer committed to protecting investors. He even admits that he knows Mary comprehends the fundamental problem with Wall Street’s culture. Pearlstein rests his argument on his belief that Mary won’t launch a brutal assault on Wall Street.
I disagree that Mary is not up to the task. When the coming regulatory reform is here, we need someone capable of knowing what is “baby” and what is “bathwater.” As someone who has worked inside the SEC twice, I can tell you that this is harder than it seems. I would have little confidence in someone without a regulatory background being able to keep level-headed.
Let’s face it. The market already has kicked off the drastic measures to clean up Wall Street. A massive correction has begun as all the investment banks have laid off thousands and none of the major ones remain on a stand-alone basis. I don’t know Mary personally, but I do know many that do – and they all say she is an independent thinker and has the utmost integrity. I believe she will be able to figure what the nature of the “assault” that Wall Street needs, without overreaching and hurting our financial system more than necessary.
3. No Confidence in a “Joe Kennedy” – From the opening of Pearlstein’s column, I guess he is wishing someone that created this crisis was tapped as the next SEC Chair, which is what FDR did when he hired Joe Kennedy as the first SEC Chair. Who is he looking for, Hank Paulson?
I can’t imagine a bigger mistake than picking someone from Wall Street to untangle this mess – and I surely doubt that type of pick would inspire confidence among the investing public. I would argue that Kennedy was picked in an era when no viable candidates were available since no real regulators existed.
4. Don’t “Clean House” at the SEC – Pearlstein basically makes two arguments against Shapiro – the first is that she won’t assault Wall Street, which I address above. And the second is that she won’t “clean house” at the SEC. I’m not sure what Pearlstein means by “cleaning house” but it scares me.
I do agree that the SEC needs an overhaul to perform more efficiently – but one thing that surely doesn’t need change is the Staff itself. Most of the people there truly believe in the mission of investor protection – and they work for little pay. When a new Chair comes in, there often are changes in key personnel (eg. General Counsel, Chief Accountant) and these changes are already underway. But beyond that, there often is little change and that is a good thing.
In fact, I would argue the converse – there has been too much “brain drain” over the past decade as some of the SEC’s finest Staffers have left to either seek more money or escape a poorly-run SEC during the current Chair’s tenure. With a better “tone at the top,” I expect we shall see an invigorated SEC that will help restore its reputation as one of the finest federal government agencies in town.
The bottom line is that we should be grateful that Mary is willing to take a large pay cut to serve as SEC Chair (from $2 million/yr. as FINRA head to $158k as SEC Chair) – and we should give her all the support she will need. Clearly, the SEC will face the biggest challenges in its history over the next few years. Here is one guy who agrees with me…
Proxy Season Items and More Meltdown Stuff (and Don’t Forget to Renew)
Since all memberships are on a calendar-year basis, please note that today is the end of the “grace period” for TheCorporateCounsel.net – meaning that if you don’t renew today, you will be unable to access Pat McGurn’s webcast on Monday: “Forecast for 2009 Proxy Season: Wild and Woolly.” Renew now for ’09! [Here is our “Renewal Center” to better enable you to renew all your expired memberships and subscriptions.]
We recently sent the Nov-Dec issue of The Corporate Counsel to the printers. This issue includes pieces on:
– Proxy Season Items and More Meltdown Stuff
– Former Executive Officers and Former Directors—Proxy Disclosure Checklist
– Item 404(a)—When Does a Law Firm Partner Have a Material Interest in the Firm’s Relationship with the Issuer?
– The Staff’s Rule 14a-3 Relief Authority
– Whatever Happened to the Proposed Amendment of NYSE Rule 452 to Ban Uninstructed Broker Voting of Street-Name Shares in Director Elections?
– Meltdown Accounting Issues
– Rule 14a-8 Practice Update
– A Suggested Alternative to Repricing Melted-Down Stock Options
– Updating Risk Factors—Update
Act Now: Get this issue on a complimentary basis when you try a 2009 no-risk trial today. And for those that already subscribe, don’t forget to renew for ’09 since all subscriptions are on a calendar-year basis.
Relief for Companies with Underfunded Plans: New Pension Bill Enacted
On December 23rd, President Bush signed the Worker, Retiree, and Employer Recovery Act of 2008, which provides relief for companies that contribute to single-employer and multiemployer defined benefit plans, as well as for certain individual taxpayers. We have posted memos regarding the new Act in our “Pension Plans” Practice Area.
Congrats to long-time SEC Staffer Shelley Parratt, who was named Acting Director for the Division of Corporation Finance last week, as John White has officially departed. Shelley will be holding down the fort until Obama’s new SEC Chair is confirmed by the US Senate (ie. Mary Schapiro) – and then the new SEC Chair has to select her new Director. So it may be just a few weeks until a permanent Director is named – or it could drag out for months.
I believe Shelley will be the first non-lawyer to hold the title, at least in modern times. There was a time when the Division was full of financial analysts – and that era could resurface again given the past year’s events. Although she looks much younger, Shelley harkens back to the days when each branch had a number of analysts among the lawyers and accountants. Now there are just a few analysts left in the Division.
Since it’s a short-time position, Shelley won’t be taking that corner office. I was on a panel with Marty Dunn a few weeks ago and asked if he had moved to the corner office when he served as Acting Director during the gap between Alan Beller and John – he didn’t make the move either. Nobody likes moving, not even if it means more windows.
Treasury Responds to Oversight Panel’s First Set of Questions
Last week, the Treasury Department posted its responses to some pointed questions posed in the Congressional Oversight Panel’s first report regarding how well EESA has been implemented.
FASB’s New Proposed Fair Value Position Likely on “Fast Track”
Last week, the FASB proposed a new Staff Position – FSP 107-a – which would require companies to provide additional disclosures about financial assets that are not measured at fair value through earnings. The comment period is very short, just until January 15th – and if approved, it could go into immediate effect for periods ending after December 15, 2008 (i.e., it would be effective for calendar year 2008). We have posted memos on the proposal in our “Fair Value Accounting” Practice Area.
Our January Eminders is Posted!
We have posted the January issue of our complimentary monthly email newsletter. Sign up today to receive it by simply inputting your email address!
Tune in later today for a Securities Docket webcast entitled “2008 Year in Review — Securities Litigation and Enforcement.” A number of my favorite bloggers are on the panel, including Francine McKenna and Kevin LaCroix.
Reasons Why Folks Do “Best of” Lists
I was tempted to concoct some type of “best of” list – and then I got sarcastic about it and created this pie chart instead:
Last winter, I noted the continuing saga of whether the typical delivery covenant in an indenture can be used to declare a default when an issuer stops filing its Exchange Act reports, and now we have yet another court weighing in on the topic.
The issue was put in play a few years ago by the New York State Supreme Court decision in The Bank of New York v. BearingPoint, Inc., and has been a source of concern as hedge funds and activist bondholders have sought to use leverage gained with delinquent issuers by declaring a default and seeking “consent fees” or acceleration of the debt. A federal court weighed in for the first time in Cyberonics, Inc. v. Wells Fargo Bank N.A., interpreting the delivery covenant at issue to require that Exchange Act reports be filed with the trustee only after being filed with the SEC, stating that Section 314(a) of the Trust Indenture Act did not independently provide a deadline for filing such reports with the SEC.
Now, in UnitedHealth Group Inc. v. Wilmington Trust Co., the Eight Circuit found that the issuer’s delay in filing its SEC reports (due to an options backdating investigation/restatement) did not violate the indenture covenant, Section 314(a) of the Trust Indenture Act or New York’s implied covenant of good faith and fair dealing. This decision is significant because it is the first federal appellate court ruling to date on this issue, and may serve to quell some of the efforts to exploit this covenant going forward.
In the meantime, issuers are well advised to revisit the covenants in their indentures, in particular any potential triggering of an acceleration by a breach of the delivery covenant. Further, the more restrictive covenant that calls for delivery of SEC filings to the trustee within 15 days after the company is required to file the reports should definitely be avoided, given that it essentially incorporates the Exchange Act’s filing deadlines as part of the issuer’s obligations under the indenture.
‘Tis the season of debt restructuring, and by the looks of things so far, it is going to get ugly. On December 18th, the Delaware Chancery Court granted summary judgment to noteholders of Realogy, who sought to block the company’s efforts to restructure its debt through an exchange offer that would have essentially permitted subordinated noteholders to jump over more senior debt in the company’s capital structure. The case is The Bank of New York Mellon and High River Limited Partnership v. Realogy.
As noted in this Simpson Thacher memo: “Realogy Corporation, an affiliate of Apollo Management, terminated its invitations to holders of its outstanding unsecured high yield notes to exchange those notes for second lien term loans under an available tranche of its senior secured credit facility after Vice Chancellor Lamb of the Delaware Chancery Court found that the second lien term loans did not constitute ‘Permitted Refinancing Indebtedness’ under Realogy’s senior secured credit facility and, consequently, the second liens securing such loans would not constitute ‘Permitted Liens’ under Realogy’s senior notes indentures.”
The court only addressed the contractual claims in the summary judgment order, staying further consideration of fraudulent transfer claims. For more on this development, check out the memos in our “Debt Financing/Loans” Practice Area.
As noted in this Bloomberg article, the Realogy case is a battle of titans in the sense that it pits Carl Icahn (as bondholder) against Leon Black (owner, through Apollo Management, of Realogy). An Icahn representative is quoted as saying: “Private equity cannot just step all over debt in order to save itself.”
SEC Delivers Mark-to-Market Accounting Study
Last week, the SEC delivered the mark-to-market accounting study mandated by Section 133 of the Emergency Economic Stabilization Act of 2008.
As previewed last month at the AICPA conference, the study recommends against suspending fair value accounting standards, and, as noted in this press release, instead recommends improvements to existing practice, “including reconsidering the accounting for impairments and the development of additional guidance for determining fair value of investments in inactive markets, including situations where market prices are not readily available.”
Yesterday, the SEC announced that it had approved changes to the disclosure requirements applicable to oil and gas companies. The Commission’s approval of these rule changes is the culmination of a long running project in Corp Fin to update the antiquated oil and gas disclosure requirements specified in Regulation S-K, S-X and Industry Guide 2. The SEC’s announcement indicates that an adopting release is forthcoming.
Noticeably absent from the announcement of the rule revisions is any indication that somehow the changes are tied to resolving the financial crisis – such proclamations have become a fixture in recent SEC announcements, orders, releases and open meeting statements. It is somehow comforting to know that, with projects such as this, life goes on in the world of adopting rule changes that are simply trying to improve disclosure for investors.
Treasury Throws GMAC a Lifeline
Last night, the Treasury Department announced the completion of a $5 billion cash infusion into GMAC, with up to another $1 billion to be loaned to GM so that it can participate in a GMAC rights offering. GMAC is struggling through the process of converting to a bank holding company, which will ultimately allow the auto finance company to access more funds through the Federal Reserve system. The GMAC funding is under the newly minted Automotive Industry Finance Program, as opposed to the Capital Purchase Program used for allocating government funds to banks. (It is just me or are all of these programs starting to sound like something coming out of the Politburo?)
Like the financing for the auto companies themselves, the GMAC financing reflects tougher executive compensation provisions than those imposed in the Capital Purchase Program’s bank financings. Not only is GMAC obligated to comply in all respects with Section 111(b) of the Emergency Economic Stabilization Act, the Term Sheet for the deal specifies that GMAC:
1. Shall not pay or accrue any bonus or incentive compensation to Senior Employees (i.e., the 25 most highly compensated employees including the Senior Officers), unless approved by Treasury;
2. Shall not adopt or maintain any compensation plan that would encourage manipulation of its reported earnings to enhance the compensation of any of its employees; and
3. Shall maintain all suspensions and other restrictions of contributions to benefit plans that are in place or initiated as of the closing date.
The Treasury also maintains the ability to claw back any bonuses or other compensation, including golden parachutes, paid to any Senior Employees in violation of any of the restrictions specified in the Term Sheet.
For more analysis of the executive compensation restrictions under the Automotive Industry Financing Program, check out this excellent blog by Mark Borges on CompensationStandards.com. If you don’t have a subscription to CompensationStandards.com, please try a No Risk Trial for 2009. If you have a CompensationStandards.com subscription, be sure to renew today so you can maintain your access to Mark’s blog and all of the other resources on CompensationStandards.com in the critical months ahead.
Capital Purchase Program Progress
Speaking of the Capital Purchase Program, over the last couple of weeks Treasury has indicated that it has closed $4.7 billion of investments in 92 local banks. If you want to see where all of the $162 billion invested to date through the CPP has gone, check out these Transaction Reports. I think that the Treasury should upgrade these spreadsheets into a full blown prospectus, since what this is starting to look like is a big government-owned financial institutions mutual fund.
Nasdaq has announced that it filed a rule change with the SEC extending – until April 20, 2009 – the exchange’s suspension of its continued listing standards which require a minimum $1 closing bid price and minimum market value. Nasdaq is seeking the extension now, given that there is little sign of a market turnaround that would provide relief to listed issuers with shares trading below $1 or with otherwise depressed market values. In its rule filing, Nasdaq notes that since the temporary suspension took effect back in October, the number of securities trading below $1 and between $1 and $2 has increased.
Nasdaq has also proposed to change the minimum bid price required for initial listing on the Nasdaq Global and Global Select Markets from $5 to $4. In its rule filing, Nasdaq indicates that it “believes that this change will permit the listing of more companies on Nasdaq, thereby enhancing investor protection by allowing these companies, and their investors, to benefit from Nasdaq’s liquid and transparent marketplace, supported by strong regulation including Nasdaq’s listing and market surveillance and FINRA’s independent regulation.” The proposed $4 price is also similar to the recently adopted requirement for initial listing on the New York Stock Exchange.
Don’t Forget to Watch those Reps and Warranties
This Sullivan & Cromwell memo notes how the Ninth Circuit Court of Appeals recently took an approach consistent with the SEC’s position expressed in the 21(a) report regarding The Titan Corporation, Exchange Act Release No. 51283 (March 1, 2005). In Glazer Capital Management v. Magistri, No. 06-16899 (9th Cir., Nov. 26, 2008), the Ninth Circuit rejected a company’s argument that a complaint alleging securities fraud should be dismissed because alleged misstatements were contained in an acquisition agreement included as an exhibit to an Exchange Act report, rather than as part of the disclosure included in the body of the report.
As 10-K season approaches, this recent decision serves as a good reminder to look at the totality of disclosure provided by the report and the exhibits, and to consider what additional explanatory language might be necessary to clearly describe the context in which representations and warranties in an agreement should be considered.
For more guidance, take a look at our “Disclosure” Practice Area on DealLawyers.com. If you are not a DealLawyers.com member, check out a 2009 No-Risk Trial, and if you are already a member, be sure to renew now for 2009.
SEC Takes Steps to Create A CDS Exchange
You know that pesky Christmas gift that you received but did not necessarily want or need in the first place and don’t really know what to do with now that you have it? It seems that the SEC was going for that effect with its Christmas Eve “gift” for the credit default swap (CDS) market (or at least some part of the CDS market).
As I have noted before in the blog, the credit default swap market has been merrily chugging along with little or no oversight from the Federales for many years now, laying the foundation for the financial equivalent of “nuclear winter” all along the way. While many have gone out of their way to note the systemic risk that these instruments have created throughout the financial system, perhaps not surprisingly CDS have only received focused regulatory attention in the past three months or so – pretty much since the stuff has hit the fan. [Other than, perhaps, the SEC’s prescient decision in June 2007 to permit trading of credit default options on the CBOE – a great way to spread some credit default exposure to retail investors who didn’t have enough already through their money market and mutual funds.]
Now the SEC has announced that it has granted temporary exemptions to allow an organization named LCH.Clearnet Ltd. to operate as a central counterparty for CDS. Further, the SEC has established (by order) an automated trading system approach for any exchange created for the purpose of trading certain CDS. All well and good, except for the fact that market participants may not have thought that they needed any such exemptions given the question of whether in fact CDS are securities subject to SEC jurisdiction. Clearly, the philosophy at play here is: “If you build it, they will come”
The SEC’s current actions are also limited by the continuing effect of that brilliant legislative initiative from sunnier days otherwise known as the Gramm-Leach-Bliley Act, which specifically excludes both non-security-based and security-based swap agreements from the definition of security under Section 3(a)(10) of the Exchange Act. The SEC points out that this inconvenient provision will continue to apply, so the Commission’s actions will only apply to those CDS that are not swap agreements.
It seems more and more likely now that the question of how to deal with CDS and the broader question of what to do about the larger OTC derivatives market will be high on the legislative agenda as regulatory reform picks up steam in the coming months.
Last Tuesday, the SEC issued this statement regarding the Bernie Madoff fraud. A number of folks have asked my opinion about the Chairman’s admission in this third paragraph:
Since Commissioners were first informed of the Madoff investigation last week, the Commission has met multiple times on an emergency basis to seek answers to the question of how Mr. Madoff’s vast scheme remained undetected by regulators and law enforcement for so long. Our initial findings have been deeply troubling. The Commission has learned that credible and specific allegations regarding Mr. Madoff’s financial wrongdoing, going back to at least 1999, were repeatedly brought to the attention of SEC staff, but were never recommended to the Commission for action. I am gravely concerned by the apparent multiple failures over at least a decade to thoroughly investigate these allegations or at any point to seek formal authority to pursue them. Moreover, a consequence of the failure to seek a formal order of investigation from the Commission is that subpoena power was not used to obtain information, but rather the staff relied upon information voluntarily produced by Mr. Madoff and his firm.
While some read the Chairman’s remarks as candid and refreshing, I read them differently. I took them as not taking responsibility for the SEC’s failures. In seeming to throw the Staff under the bus – on his way out of the agency’s doors no less – the Chairman violates the “tone at the top” mantra as well as the one of “accountability” that the SEC is supposed to drum into our corporate leaders.
From the beginning, I didn’t like it that a sitting Congressman was appointed as the head of an independent agency. The SEC was already being “politicized” before Cox arrived, but this trend accelerated on his watch. And some say that Cox cared more about how the media perceived him than how the Staff performed (one of his responses to the credit crunch was hiring two more PR guys). It has been written that he fought budget increases for the SEC (albeit with some urging from Commissioner Atkins), even when those in Congress responsible for the SEC’s oversight urged him to seek more resources. Anyways, the SEC is in dire straights these days and a new Chair couldn’t come at a better time.
CEOs and Boards: “We Didn’t Do It”
Now, I’m certainly not blaming Chris Cox for this financial crisis (nor do I blame him for any failures in not catching Madoff – I just don’t like the manner of his admission). The government isn’t to blame for the greed that greased this wheel. What blows my mind is the “tone at the top” of our country’s leaders in the aftermath of this crisis. President Bush recently has said that he’s not to blame because all of the problems related to the crisis started before he got in office (somehow ignoring the fact that he is responsible to fix anything broken while he’s in office; plus ignoring his role as outlined in this NY Times article). More importantly, the CEOs and boards of this country have shown no remorse for the pain that “Main Street” is now feeling due to their missteps.
This Washington Post article about General Motor’s recent apology describes the cultural difference between corporate leaders in this country compared to others like Japan. In Japan, CEOs would be publicly apologetic if they were on the job during a time like this, offering up their resignations. In our country, there is no humilty, no true leadership. Rather, there is a rush to revise compensation arrangements to take advantage of a down market to reprice, etc.
Holding CEOs Accountable: Boards Last to See What’s Wrong
In a WSJ editorial last week, Yale Professor Jonathan Macey wrote these interesting words to describe what has happened here:
The failure of the General Motors board of directors to fire CEO Richard Wagoner provides a rare glimpse into the inner-workings of big-time corporate boards of directors. The sight is not pretty.
When Mr. Wagoner took the helm eight years ago the stock was trading at around $60 per share. The stock had fallen to around $11 per share before the current financial crisis. It’s now below $5 per share.
In 2007, Mr. Wagoner’s compensation rose 64% to almost $16 million in a year when the company lost billions. The board has been a staunch backer of Mr. Wagoner despite consistent erosion of market share and losses of $10.4 billion in 2005 and $2 billion in 2006. In 2007 GM posted a loss of $68.45 a share, or $38.7 billion — the biggest ever for any auto maker anywhere.
The GM board is now reportedly meeting several times a week. But beneath the appearance of activity, nothing is happening at GM other than the company’s poorly articulated pleas for a government bailout and threats of dire consequences if GM is not bailed out.
When Connecticut’s Sen. Chris Dodd mentioned that Mr. Wagoner might have to go, GM spokesman Steve Harris was quick to defend him: “GM employees, dealers, suppliers and the GM board of directors feel strongly that Rick is the right guy to lead GM through this incredibly difficult and challenging time.”
The average pay for chief executives of large public companies in the United States is now well over $10 million a year. Top corporate executives in the United States get about three times more than their counterparts in Japan and more than twice as much as their counterparts in Western Europe. In my new book “Corporate Governance: Promises Made, Promises Broken,” I argue that executive compensation is too high in the U.S. because the process by which executive compensation is determined has been corrupted by acquiescent, pandering and otherwise “captured” boards of directors.
Like parents unable to view their children objectively, boards reject statistical reality and almost always view their firms as above average. Because directors participate in corporate decision-making, they inevitably take ownership of the strategies that the corporation pursues. In doing so, directors become incapable of evaluating management and strategies in a detached manner.
As board tenure lengthens, it becomes increasingly less likely that boards will remain independent of the managers they are charged with monitoring. The capture problem is exacerbated by the incentives of managers to develop close personal ties with directors. Mr. Wagoner has had 10 years to cultivate his board. Of the 13 “independent” directors on the board, eight of them have served with Mr. Wagoner since 2003.
Once an opinion, such as the opinion that a CEO is doing a good job, becomes ingrained in the minds of a board of directors, the possibility of altering those beliefs decreases substantially. All too often, it is only when an outsider takes an objective look does anybody realize the obvious: That the directors of a company are generally the last people to recognize management failure.
We need to encourage market solutions — not bureaucratic ones — as the best strategy for addressing the corporate governance failures we face today. Hedge funds and activist investors like Carl Icahn are the solution, not the problem. The market for corporate control should be deregulated and the SEC’s restrictions on all sorts of equity trading should be lifted at once.
Little if anything has changed at GM since dissident director H. Ross Perot dubbed his board colleagues “pet rocks” for their blind support of then CEO Roger Smith. The broader problem is that there are far too many pet rocks on the boards of other U.S. companies.
A few weeks ago, the White House issued an executive order making this Friday, the 26th, a day off for the US government. It’s not uncommon for the day before – or after – Christmas to be declared a federal holiday by a Presidential executive order. [Added note – The SEC issued this related press release on Tuesday.]
1. Business Day for ’34 Act Report Deadlines – Friday will not be considered a business day for Form 4 and other ’34 Act deadlines. It’s considered just like a federal holiday for deadline purposes (see Rule 0-3(a)).
2. Tender Offers – If you are counting your 20 business days for a tender offer, it is my understanding that the SEC staff takes the position that if the offer is ongoing, you can still count the unscheduled Friday holiday in the 20 days. But you shouldn’t end the offer – or start it – on Friday.
3. Filing Deadline for Form SH – The Form SH weekly filing deadline is the last business day of the calendar week following a calendar week in which short sales are effected. Due to the Executive Order requiring the federal government to close on December 26th, the last business day of this calendar week is Wednesday, December 24th. Accordingly, Form SH filings disclosing this week’s positions must be submitted by 5:30 pm Eastern on December 24th to be deemed timely filed. [Update – Different Staffers (ie. Corp Fin vs. IM) are saying different things about this one. So it’s uncertain if they are due on the 24th or can wait until the 29th.]
FASB Adopts New Securitization Disclosures Effective This Year
Recently, FASB issued a new FSP FAS 140-4 – entitled “Accounting for Transfers of Financial Assets” – which increases disclosure requirements about transfers of financial assets and variable interest entities. This FSP is effective now since it’s for reporting periods (interim and annual) that end after December 15, 2008.
The FSP is being adopted in connection with broader amendments that FASB proposed in September to Statement 140 and FIN 46(R). The two proposed amendments would significantly change accounting for transfers of financial assets, the criteria for determining whether to consolidate a variable interest, and associated disclosures. The amendments, if adopted, would be applicable for fiscal years beginning after November 15, 2009. We have posted memos analyzing these proposed amendments in our “Off-Balance Sheet” Practice Area.
FINRA: First Batch of “New” Rules
Recently, FINRA issued a Notice advising that the first group of consolidated FINRA rules were effective as of December 15th. In addition, FINRA has published this nifty rule conversion chart showing the conversation of NASD to FINRA rules (see links to two other conversion charts on the right side of the page). The conversion chart references the relevant rule filing number that is hyperlinked to each rule filing, which filings provide a statement of the purpose of the rule change and the text of the changes between the NASD or NYSE rules and FINRA rules (where applicable). FINRA will issue additional effective date notices every time they update the FINRA Manual until the process is complete.
After repeatedly being passed up for any sort of blog awards (the blog is six and a half years old!), Dave and I finally made the “ABA Blawg 100″ list. We are grateful for the recognition, particularly since we know that the corporate & securities law community does read our stuff (for some reason, the annual blog lists typically are dominated by law-marketing oriented blogs and solo practitioners).
Now, if we can only get Jesse Brill recognized in the “Directorship 100.” The list purports to be about the 100 “most influential players in corporate governance” – but there are many on the list that have never expressed a public opinion about their governance views (and even a few who are not a friend of good governance).
Not only is Jesse not afraid to take a position that might not be popular with his corporate colleagues, he has developed practical tools and processes to effectuate change towards responsible executive pay practices. He pushed tally sheets until they became mainstream – and now he has pushed internal pay equity, wealth accumulation analyses and hold-through-retirement provisions so that they soon also will become the norm (many Johnny-come-lately organizations are rushing to issue papers about these now hot topics). Over the years, he has convinced some big name CEOs (egs. John Reed, Jamie Dimon) to speak at our annual Conference about responsible pay practices, a task much harder than you can imagine!
Being on any of these lists is certainly nice, but I would take them all with a grain of salt. That’s why we have never created any sort of lists (despite the temptation to do so, as it generates a lot of media attention – we all sure do love our lists).
The FASB’s “Alternative Model” for FAS 5 Loss Contingencies
On Monday, the FASB issued its long-awaited “alternative model” for disclosures of loss contingencies under FAS 5. Described in this handout from a meeting of the FASB Advisory Council, the model is characterized as “a collection of ideas that the staff would like to field test” – and is not intended to represent either the FASB Staff’s or the Board’s proposal for a final statement.
Her Majesty’s Government: Corp Fin Grants Schedule 13D Relief for UK’s Investment in the Banking Sector
From the DealLawyers.com Blog: Last week, Corp Fin issued this no-action letter entitled “Her Majesty’s Government.” Is that the coolest name for a government response or what? It’s so “James Bond.”
Corp Fin’s relief allows the United Kingdom to file an “Alternative” Schedule 13D when the UK Treasury takes ownership interests in the UK banks that is taking place due to the recapitalization of the UK banking industry, a recap “scheme” blessed by the Bank of England and the UK Financial Services Authority. For example, the UK Treasury is acquiring a 57.9% interest in the Royal Bank of Scotland’s holding company.
The “Alternative” Schedule 13D is intended to dovetail with the notification required to be filed with the FSA under DTR 5.1.2R (this is in Chapter 5 of the FSA’s “Disclosure & Transparency Rules”). Under Corp Fin’s relief, this alternative 13D will consist of a cover page, the UK notification and the 13D signature page. A form of the alternative Schedule 13D is attached as Annex I of the incoming letter of the no-action request – and here is the alternative Schedule 13D filed by the Royal Bank of Scotland.
Why Hasn’t the US Treasury or Fed Filed Any Schedule 13Ds?
What about Schedule 13Ds filed by the US Treasury or the Federal Reserve for their investments in AIG, Fannie, Freddie, etc.? We looked pretty hard for Schedule 13Ds filed by the US government and didn’t find any. We aren’t the only ones wondering where these filings are – Professor Davidoff mused about this also a while back.
Just like the Professor, at first, the only rationale I could think of was that the Treasury figures nobody is going to sue it for not meeting filing requirements. But then I remembered Section 3(c) of the Exchange Act, which provides an exemption from the provisions of the Exchange Act for “any executive department or independent establishment of the United States, or any lending agency which is wholly owned, directly or indirectly, by the United States, or any officer, agent, or employee of any such department, establishment, or agency, acting in the course of his official duty as such….” Depending on the nature of the entity making the investment, it may be able to rely on Section 3(c) to avoid filing beneficial ownership reports. So that may be what is being relied upon…
Congrats to Betsy Murphy, who was named the SEC’s Secretary. Betsy has served in Corp Fin for many years, including as the head of rulemaking. She will get a great asset to the SEC in her new position!
