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…
In testimony last week before the Senate Banking Committee, SEC Chairman Cox pointed out the enormous regulatory black hole in which credit default swaps have come of age since pretty much the dawn of the 21st century. He pointed out that the SEC’s Enforcement Division was focused on using its antifraud authority in this area, and noted that credit default swaps provided a way for market participants to “naked short” the debt of companies without restriction. Cox asked that Congress “provide in the statute the authority to regulate these products to enhance investor protection and ensure the operation of fair and orderly markets,” but he didn’t say who should have such authority. Interestingly enough, I don’t recall any similar discussion of the lack of authority to regulate credit default swaps and other derivatives up until this point, while the excesses in the market – and the lack of transparency – have been known for some time.
A day earlier, New York Governor Paterson and the New York Insurance Department announced that, beginning on January 1, 2009, the New York Insurance Department would regulate some credit default swaps as a form of financial guaranty insurance, whenever the credit default swap is issued in New York or issued to a New York purchaser who “holds, or reasonably expects to hold, a ‘material interest’ in the reference obligation.” Governor Paterson also called on the federal government to regulate credit default swaps.
One interesting thing pointed out by the statements of Chairman Cox and Governor Paterson is that no one seems to know for sure how big the market is for credit default swaps. Chairman Cox cited in his testimony “the $58 trillion notional market,” while Governor Paterson referred to the “$62 trillion market.” Any estimates such as these are pretty much educated guesses, since there really isn’t any transparency into the scope of the credit derivatives market. Also, these types of notional amount estimates are often cited to state the size of derivatives markets, but really those amounts overstate the actual exposure that these derivatives present, since the notional amount is really just the basis on which payments are calculated – but not how much any counterparty owes on the actual derivative contract. Something closer to $2 trillion in fair value is perhaps a better estimate of the size of the credit default swap market, at least up until the events of the last few months.
Congress did not yet heed the calls for more federal authority over credit default swaps, as no provisions have been included in the two versions of the bailout bill that would vest regulatory authority over credit derivatives with the SEC or any other agency; however, this may be an issue that Congress will turn to quickly once the latest fire drill has died down.
While I am by no means running for president of the credit default swaps fan club, I think that now is the absolute worst time to start beating the drum for more regulation of derivatives in general and credit derivatives in particular. While speculative activity in credit default swaps no doubt contributed to some of our problems today, credit derivatives have also mitigated risk for countless institutions by spreading the risk of default around the globe. Policymakers should have been paying attention long ago, before the market has grown to the size – and level of interconnectedness – that prevails today. Now, vague talk of regulation only serves to call into question the enforceability of agreements, make counterparties even more nervous about ultimately collecting on their contracts, and put further pressure on credit markets when those markets are least able to handle the pressure.
A Change to the Audit Committee Report
Back in the summer, the SEC approved the PCAOB’s new rule regarding communications with audit committees regarding independence. Last week, the SEC made a conforming amendment to Item 407 of Regulation S-K to change the language of the audit committee report. Previously, the audit committee report referred to “Independence Standards Board No. 1 (Independence Standards Board No.1, Independence Discussions with Audit Committees), as adopted by the Public Company Accounting Oversight Board in Rule 3600T.” Now, the audit committee report must refer to “applicable requirements of the Public Company Accounting Oversight Board regarding the independent accountant’s communications with the audit committee concerning independence.” The applicable requirement is PCAOB Rule 3526, but apparently the SEC does not want to refer directly to the rule itself.
The SEC didn’t amend Item 407 Regulation S-B, which is hanging around for transition purposes until March 15, 2009. But the SEC said interpretively that any filers using Regulation S-B should follow the Regulation S-K language in their audit committee report.
The change to Item 407 of Regulation S-K was effective on September 30.
This September-October issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:
– Boards Can’t Watch a Sale Unfold from the Balcony: Nine Take-Aways from Lyondell
– Dealing with State Anti-Takeover Statutes in Negotiated Acquisitions
– Cross-Border M&A: Checklist for Successful Acquisitions in the US
– Outside Termination Dates: No Way Out from a Purchase Agreement
– Broken Deals: Validation of Naked No-Vote Termination Fee
– Lessons Learned: Seeking Block Bids as Schedule 13D Discloseable Events
– The Shareholder Activist Corner: Spotlight on Steel Partners
Try a 2009 no-risk trial to get a non-blurred version of this issue (and the rest of ’08) for free.
Last night, the Senate voted 74 to 25 in favor of Emergency Economic Stabilization Act of 2008, seeking to create an offer that members of the House can’t refuse when the bill goes up for a vote there by Friday. Here is a Summary and Section-by-Section Analysis of the 451-page bill. As noted in this NY Times article, some of the “sweeteners” added to the Senate bill have nothing to do with the credit crisis or the bailout, including $150 billion in tax breaks for individuals and businesses and legislation requiring insurers to afford parity between mental health conditions and other health problems. The Senate also adopted a temporary increase in the FDIC’s limit on insured bank deposits, raising the ceiling from $100,000 to $250,000.
As Mark Borges noted last night in his CompensationStandards.com blog, the only substantive change to the corporate governance and executive compensation provisions of the House bill was in Section 111, where the limits on compensation that Secretary of the Treasury must adopt to exclude incentives for encouraging executives to take unnecessary and excessive risks now applies to “senior executive officers,” rather than just “executive officers.” As Mark notes, this change is consistent with the application of the other two standards in Section 111 and thus limits all of these provisions to the “named executive officer” group. Apparently, the Senate did not see the need to add any real teeth to the executive compensation and corporate governance provisions of the bill, perhaps because any changes along those lines might not have improved the bill’s success in the House.
Now the market will be on pins and needles until the House acts. After the market’s swoon on Monday, it seems much less likely that constituents will be beating down members’ doors opposing the plan. At this point, whether there will be enough support to pass the bill in the House is anyone’s guess.
SEC Extends Emergency Orders
The SEC announced that it has extended its short sale emergency orders, as well as the emergency order loosening the timing and volume conditions on issuer repurchases in Exchange Act Rule 10b-18. The SEC also announced that the Form SH filing requirement for Exchange Act Section 13(f) filers is also extended, and will become a permanent requirement under interim final rules that the SEC plans to adopt. Based on the language of the press release, it doesn’t appear that information filed on Form SH (under the emergency order at least) will be made public. What the SEC plans to do with the information on short positions obtained on Form SH remains a mystery, and the fact that the information is not being made public seems a little at odds with the SEC’s “full disclosure” mission.
The SEC stated in a press release that the orders are being extended to “allow time for completion of work on the anticipated passage of legislation,” referring to the Congressional efforts to pass a bailout plan. The order banning short selling in “financial” companies is extended until 11:59 p.m. eastern time on the third business day after enactment of the legislation, but in any case no later than October 17th. The order requiring the filing Form SH will be extended until October 17th, but the requirement will remain in place after the expiration of the order under to-be-adopted interim final rules. The relaxed Rule 10b-18 conditions will be extended through October 17th.
The emergency order specifically directed at naked short selling – through Rule 204T, the repeal of the options market maker exception from short selling close-out provisions in Reg. SHO, and Exchange Act Rule 10b-21 – has been extended through October 17th. The SEC also adopted the Staff’s guidance on the application of the initial order. It appears from the press release that the SEC plans to adopt interim final rules to implement this order on a permanent basis as well.
It seems odd that the outright short sale ban on shares of financial companies is now tied to the legislative efforts in Congress. That approach seems to pin a lot of hope on the fact that just the enactment of the legislation (no matter how the legislation comes out) will restore order and calm to the markets. For those companies who are not on the list of companies subject to the ban but who have seen their competitors added to the list, it makes it tougher to judge whether they should contact the exchange to get added, since there is now significant uncertainty as to how long the order will actually remain in effect. In any event, this much is assured: when the ban is lifted, people will go right back to shorting companies with bad assets, bad management and little prospect for success.
Our October Eminders is Posted!
We have posted the October issue of our complimentary monthly email newsletter. Sign up today to receive it by simply inputting your email address!
Last night, Corp Fin posted a series of new Compliance and Disclosure Interpretations replacing three sections of the Manual of Publicly Available Telephone Interpretations. The new Compliance and Disclosure Interpretations cover:
These Compliance and Disclosure Interpretations include many of the old Telephone Interpretations, as well as a number of new notable interpretations that answer some fundamental, recurring questions.
For example, Question 130.02 of the Exchange Act Sections Compliance and Disclosure Interpretations notes that a delinquent filer must file all delinquent reports in order to be considered current in its Exchange Act reporting. Delinquent filers often ask the Staff if they can become current by filing the latest Form 10-K or some sort of consolidated “catch-up” filing, and now this interpretation makes clear that all missed reports must be filed. Further, Questions 116.04 through 116.06 of the Exchange Act Sections Compliance and Disclosure Interpretations address the issues around the automatic effectiveness of a Form 10, including the ability to withdraw the Form 10 in limited circumstances prior to effectiveness and the necessity of filing Exchange Act reports once the Form 10 is automatically effective, even if the Staff’s review of the Form 10 is ongoing.
In the Exchange Act Rules Compliance and Disclosure Interpretations, the Staff includes some detailed guidance on the ability of companies to use an effective Form S-3 during and after the Rule 12b-25 period, as well as some helpful guidance on delisting and deregistration mechanics. Further, following up on some helpful guidance in the Regulation S-K Compliance and Disclosure Interpretations posted over the Summer about correcting CEO/CFO certifications (see our discussion of those interpretations in the July-August 2008 issue of The Corporate Counsel) , the Staff has consolidated much of its guidance on CEO/CFO certifications in new Compliance and Disclosure Interpretations under Exchange Act Rule 13a-14.
Fair Value Accounting Guidance from the SEC and FASB Staff
In the face of intense lobbying calling for the suspension of fair value accounting, the SEC’s Office of Chief Accountant and the FASB Staff issued a press release outlining a series of “clarifications” on fair value accounting.
The press release answers the following questions on the application of FAS 157:
1. Can management’s internal assumptions (e.g., expected cash flows) be used to measure fair value when relevant market evidence does not exist?
2. How should the use of “market” quotes (e.g., broker quotes or information from a pricing service) be considered when assessing the mix of information available to measure fair value?
3. Are transactions that are determined to be disorderly representative of fair value? When is a distressed (disorderly) sale indicative of fair value?
4. Can transactions in an inactive market affect fair value measurements?
5. What factors should be considered in determining whether an investment is other-than-temporarily impaired?
While the new Staff guidance is not inconsistent with what has been said before, it appears that the intent is to provide at least some flexibility for issuers to depart from market prices in certain circumstances, particularly when an active market does not exist.
It seems unlikely that the latest round of guidance will satisfy the mounting criticism of fair value accounting. Yesterday, a bipartisan group of 65 House members sent a letter to Chairman Cox asking that the SEC immediately “suspend” mark to market accounting in favor of a “mark to value” mechanism that “better reflects the value of the asset.” The Congressmen state that until new guidance is put in place, the fair value of assets should be estimated by “using the best available information of the instrument’s value, including the entity’s intended use of that asset, from the point of view of the holder of that instrument.”
Some opposition to the suspension of fair value is emerging. Last week, Federal Reserve Chairman Bernanke told the Senate Banking Committee that abandoning fair value “would only hurt investor confidence because nobody knows what the true hold-to-maturity price is” (as noted in this Reuters article), while this article by Judith Burns of the Dow Jones Newswires reports that US accounting firms are now opposing calls for rescinding mark to market accounting.
The Rise of Sovereign Fund Investing
Tune in tomorrow for this DealLawyers.com webcast – “The Rise of Sovereign Fund Investing” – and hear about the role of sovereign wealth funds in this crisis marketplace and more:
– G. Christopher Griner, Partner, Kaye Scholer
– Michael Hagan, Partner, Morrison & Foerster
– Jerry Walter, Partner, Fried Frank Harris, Shriver & Jacobson
– Steven Wilner, Partner, Cleary Gottlieb Steen & Hamilton
